Banking compliance a big IT opportunity: Pankaj Ghemawat

Pankaj Ghemawat is the Anselmo Rubiralta Professor of Global Strategy at the IESE Business School in Barcelona. He completed his PhD from the Harvard Business School at the age of 22 in 1991 and was appointed the youngest full professor in the history of the institution. In this interview, Ghemawat speaks to DNA.
Excerpts:

How has Indian IT weathered the global financial crisis?
An environment like this always leaves some risk. So there are some risks facing the industry. But overall, what we are seeing — and this is evident in the financial results of companies, especially the majors, which have actually come out of the crisis relatively fast — at places like TCS are margin improvements as well as rapid growth.

TCS recently overtook Infosys in market cap. Are the days of Infosys as the blue-eyed boy of the stock market over?
The trend is a very encouraging one from TCS’ perspective, particularly once we recognise that because of reputational effects, changes in market valuations take a while to reflect real improvements in operating performance.   

What we saw for a longish time was a situation where the companies that were the first to list publicly received extra attention and were placed in a different bracket from major competitors such as TCS, which listed later. That, among other changes, that historic asymmetry, has faded.

Looking forward, relative valuations will be influenced more by who is better positioned to do really new things, move into new market segments, execute mega deals, etc — all elements of TCS’s strategy for some time now. In contrast, competitors who historically grew more quickly by focusing and, in effect, doing similar projects over and over again will, at a minimum, have to change how they compete.

So do you see companies like Infosys correcting that now?
It is a little bit hard to tell from the outside but I would assume that a change in relative market share valuation must be the topic of huge discussion because in some sense this was the metric Infosys placed a heavy emphasis on, whereas TCS placed comparatively more emphasis on delivery and other operating metrics.

Have you seen the Indian IT business evolving in some way due to the financial crisis?
It is a little hard given how fast the sector is growing to decouple changes that would have happened anyway from changes that are a direct result of the financial crisis. But there are specific responses I can think of. For instance, take banking.

Given the regulations that have been put into place, and are being put into place, there is a whole new, banking compliance IT business, that is just getting of the ground, but is potentially a huge opportunity for those who have the ability to move in their quickly.

So normally we think of a crisis as reducing economic opportunities there is clearly some respects in which it has expanded it. The challenge is going to be maintain the right balance between learning to do new things and recognising that there is huge demand for the traditional business at very good margins to be made.

So one of the things I keep encouraging people is while of course you must think of doing new things but recognise that for the majors this is a beautiful business model that has delivered for a number of years now and don’t lose sight of that. This is because very few industries are structurally as attractive as the Indian software sector.

Any other issue?
I did the keynote speech to Nasscom in February 2009 and what I told them at that time was that in terms of the protectionist trends
we haven’t yet seen all that could happen. While I have been encouraged in the short run that governments haven’t responded with quite the protectionism one might have feared, the story remains to be told. And the very fact that employment is such a sensitive issue.

The fact that it has become harder to recruit US companies to stand side by side with Indian companies on Capitol Hill and press for increasing the number of H1B visas etc — it’s a different situation. So the industry justifiable takes credit in having weathered some of the public relations problems that it had and the lobbying issues that it faced in 2001-02.

So the point you are trying to make is..
My point to the industry is that given the global macroeconomic climate it is both really good news and really bad news. The good news, in some sense, is that more cost-effective IT is more of a priority for companies than ever. The bad news is that in terms of protectionism we are in unchartered waters and the waters may be about to get rougher in the sense what we are seeing is the expiry of the effect of the stimulus packages.

And governments were able to coordinate on that because no politician ever saw a spending increase, unless they are very conservative, that they didn’t like. You know, pumping lots of money into the economy has a certain natural constituency to it in politics.

I think that masked a lot of attention that one starts to see in a climate of excess supply and insufficient demand. And that’s why I remain quite worried about protectionism if the job situation doesn’t improve. And with people starting to talk, I mean this happens every two days, I wouldn’t rate it as a major turning point, but with people starting to talk about a double-dip US recession, this is kind of a reminder of how fragile the macroeconomic situation is and clearly if the macroeconomic situation deteriorates, protectionist pressures escalate.

You are based in Spain and sitting in India. Reading the international press, one gets a feeling that things are not quite well there. What will be the impact of the PIIGS crisis on Indian IT companies?
Well, actually in Spain, we don’t like the PIIGS label, but it does have the advantage of compactness. Basically, the Indian IT sector speaks English as its first language, so if actually you look at the geographic distribution of revenues, the fraction coming from the PIIGS countries, I would suspect, will be less than 5% of the total.

The bigger problem is the knock-on effect of the PIIGS crisis on overall economic growth in the Eurozone and, through the effects on business confidence and companies’ investment plans. This is important because there is potentially a big opportunity for Indian companies in Europe.

Study after study shows that the difference in productivity growth rates between the US and European companies since the 1990s — US companies have, on average, improved faster — is largely explained by the differences in IT intensity and usage. So, on the one hand, there is this huge latent opportunity; on the other, the macroeconomic situation in Europe continues to deteriorate, and you don’t see companies stepping up to make the kind of investments required to overhaul IT systems.

So Europe has a particular uncertainty from the standpoint of Indian companies. I know some companies like TCS continue to push, but they are larger than everybody else and have more of a focus on global deals. Whether it makes sense for some of the companies, which have just started doing some stuff in Western Europe, to continue to make that a priority market, I don’t know. At a minimum it’s a wait and see situation, I would say.

Indian IT companies have done well in the developed world. But do you see them doing well in the developing world? Like do you see Infosys and TCS capturing business opportunities in China?
It varies a little bit by firm. Firms that historically emphasised the Indian market and have been doing business in the Indian market probably have a better shot at working in other emerging geographies than companies that were very clear that they would simply work in the markets where the rates were the highest.

You know how the IT companies differ on that dimension, I won’t put any names there. Clearly different companies have different experience bases. So its like the difference between a company that focused historically on doing largescale IT projects for the Indian government and a company that said no, we are not interested in that kind of work, saying our clients are in developed markets. Obviously there will be a differential there.

With the Bharti-Zain deal there has been a lot of talk about business opportunities in Africa. Do you see Indian IT companies heading that way? Are Indian IT companies already doing business in Africa?
Yeah I know that TCS does some business in South Africa. Certainly in the Middle East, which comes under the expansive definition of Africa. TCS has a development centre in Morocco meant to serve the Francophone geographies. You know the problem and this is kind of retreating from IT to a sort of longer run perspective on Africa.

I remember being at lunch with Jim Wolfensohn, who used to run the World Bank till last year. Jim was talking about some unpublished World Bank study that has income projections for the year 2050. Income projection for the US was $100,000 per capita in today’s terms. India was still at $20,000-3,0000. But the most striking thing he said at that lunch was that World Bank’s own forecast for African GDP per capita for 2050 are at $2,000-4,000 per capita.

If that’s the overall macroeconomic situation, I wonder how the market will be 2050. IT may go in for other reasons, maybe it’s the way of breaking the logjam of African development, but I find it stunning, I also find it stunning that the World Bank can sit around and make 40-year forecasts that basically involves zero economic growth, given that it’s supposed to be their job. I do think that there are aggregate market-size issues.

The way of dramatising that is if you draw the map of the world that respects the geometry of the world but where the areas of countries are proportionate to GDPs, Africa looks like slender thread with a little pearl, South Africa, hanging at the bottom. That’s how Africa shows up on the world map economically. Africa, yes, but there are huge variations within Africa.

It is not like the Zain deal is going to take Bharti into the most difficult parts of Africa. But overall, if one were to paint with a very broad brush, that $2,000-4,000 per capita projection raises huge questions in my mind about what is going to happen and at a broader level whether globalisation is sustainable in the face of of 25 to 50-fold income differences between one continent and all the rest.

That is a very interesting point...
It’s a huge worry..

Has the success of Indian IT something to do with our ability to speak, read and understand English? I say this because Indian IT companies haven’t been able to make a mark in markets like Japan?
Of course you have picked what is, among other things, the world’s toughest market for foreigners. It varies from business to business. There are businesses that are relatively easy to do in Japan, but anything involving offshoring in Japan, with a lifetime employment culture -basically what I have heard from talking to various companies, not just TCS, is that the only way of getting Japanese business is to have a Japanese front end where you buy somebody and they bring their network of relationships, etc.

So Japan has been a problem for everybody, although IBM, by virtue of having been there for decades and really having Japanised some of the face, has done relatively well compared with many foreign competitors.

Secondly, I have this little framework for thinking about differences between various countries and if you look at Japan on that, compared with a much smaller market but a more significant market for Indian companies like Australia, you know, okay, what are the differences culturally? Language is a huge issue. How many Indians speak Japanese? But it also goes beyond that. I think of Japanese food (breakfasts, especially) and how happy an Indian guy would be about staying onsite in Tokyo on a budget.

And then there are issues of ethnicity. Personally I’d say Japan is where I feel ethnically least comfortable in the world. So just think of the experience of people going there, it’s hard — and quite a few want to come home relatively soon. This brings up one of the most fundamental points that I stress about global strategy: the whole objective of recognising that different countries are different — realise that your global business does not and probably should not look like a miniature replica of world demand.

Just because of X% of world demand is in Japan, it doesn’t mean X% of your sales should be from Japan if its the hardest market to get into. So for most Indian companies the bulk of the revenues and an even greater share of profits comes from English-speaking geographies.

What about Latin America?
That’s the big exception, at least from the TCS perspective. I haven’t been down there for a while, but will be headed there next month for a workshop with the Latin American TCS operations. Whereby hangs a point. Those operations are already large enough that we are thinking of having to do things like strategy development workshop etc at the regional level. TCS is past or should be close to 7,500 people in Latin America.

The other operations are still significantly smaller because TCS was very aggressive in the Southern Cone, early on. From the TCS perspective, Latin America embodies its attempt to speak Spanish as a second language (or Spanish and Portuguese, actually, because Brazil is a big part of the Latin American play). It also illustrates the point that it is interesting to think about regions that might not be quite geographic in an industry that is so language driven: there are clear synergies between TCS’s Latin American operations and its operations in the Iberian peninsula — Spain and Portugal — so that at one point, IberoAmerica was one of the “regional” groupings within the company.

What are the challenges in Latin America?
Language is the obvious difference. Then there is the time zone difference. We are used to dealing with the difference between the Indian time zone and the US time zones. But there is still a whole level of unfamiliarity brought by differences in the Northern and Southern hemisphere. The businesses have certain seasonality given when Latin Americans take their vacation.

There are some direct cultural differences as well. I remember that when TCS started  in Uruguay, which, along with Argentina, is a beef consumer par excellence, there were significant issues around food. Hindus don’t want to be close to beef eaters and, for their part, many westerners do not find the odour of Indian cooking appealing, strong though it might be.

And then there are differences in work style. As one person in the region explained it to me — this is an overstatement but does highlight a real issue — Indians live to work whereas Latin Americans work to live. So that requires some sort of thinking on how many meetings do you want to have on a Saturday, when is it appropriate to call somebody and when is it not and so on — the sort of detailed HR stuff that you have to just figure out by being on the ground. And I would say that the big benefit is the amount of multiculturalism engendered within TCS — much greater than what might have been expected from just running diversity programmes and so forth internally.

Where will the next phase of growth of Indian IT companies come from?
There are very interesting things going on in emerging markets. Again, if I am worried about Africa’s share of world income in 2050, one can’t help but note that Chinese and Indian share of world GDP at least in purchasing power parity terms is supposed to be back to 45% or 50% of world GDP.

Like it or not, this is something I tell clients in the West as well as in India — if that kind of shift in global demand of purchasing power is going on, some companies may elect to sit that one out, but most companies have to think hard before ruling out that option — on how are they going to participate in that. Very, very frankly the Chinese IT sector is still very complicated for Indian companies.

What about the Indian market itself?
The Indian market is very interesting. Some companies have
been, as I said earlier, pursuing this all along. Some have recently started. What has been striking for

me is the fact I found pricing for some of the deals surprising based on what I know of the industry
and also the kinds of re-specifications and change orders and so forth, that typically comes on for a mega project for a governmental entity in India. One wonders whether some of the people who are getting into this for the first time fully understand what’s the cost of serving going to be.

Do you see the rise of Chinese IT companies?
We maybe taking false comfort from this. A co-author of mine, a former senior partner at BCG, and I have a piece under review right now where we basically try and make sense of recent developments in Chinese policy. And our sense is that the Chinese are really dissatisfied about where they have gotten with their manufacturing assembly strategy.

The most notorious example is the iPod. You take an iPod with a retail selling price of $170 that says Made in China. An interesting study that has been done pointing out that the Chinese value added of that is less than $5. So they have basically become the assembly workshop for the far east, for the Taiwanese and the Japanese. They aren’t happy about what it has added to their technological prowess, and so what we are starting to see in a lot of sectors and a number of MNCs report this, that the Chinese are getting much much more explicit and heavy-handed about technology transfer than they have been even up till now.

For now their focus on the IT sector is more on the visible package and utility providers like Microsoft and Google. Microsoft has learnt to play the game, Google is learning. Indian IT services companies, for the moment, factor fairly far down low in the list of the technologies they’d like to get. Although inevitably they will figure out that the project management capabilities that these companies have built are valuable and they will try and figure out how to build those in China.

But right now the segments the Indian companies are focused on is not the ones that the Chinese government is going after, even though there is a general push, we argue, to fundamentally trade the technology terms of trade.