Growing Pains

The last decade has seen the phenomenal rise of the Indian IT sector. Total IT revenues have touched US$ 40 billion and are expected to be around US$ 70 billion by 2010. In spite of this impressive performance, the IT industry continues to be highly fragmented consisting of hundreds of small companies. When the going was good these companies were highly profitable, thanks to a major demand-supply imbalance.

However, recent reports suggest that the small companies have been worst hit by the rupee appreciation and demand slowdown in global markets leading to serious challenges for survival.

The journey so far

The common factors that have contributed to the growth of this industry are skilled manpower, export orientation, policy initiatives of the government and the network of expatriate Indians in global customer organisations.

Low entry barriers, high profitability, a favourable regulatory regime and a high growth market encouraged entry of new players to the IT industry at a rapid pace. Since the beginning of the new millennium, dotcom bust, significant reduction in technology investments, a relentless focus on cost reduction, shift from 'onsite' to 'offshore' and rupee appreciation have all thrown up a formidable challenge to SMEs in IT who wish to stay in business and grow.

Market perspective

In order to appreciate the reasons behind the struggle of SMEs in IT, in a market that is far from being saturated, we need to understand the market dynamics. We believe that the market for IT services comprises three distinct segments. First and the largest in terms of potential is the enterprise segment, whose core business is not IT.

The second segment is the independent software vendors (ISVs), whose core business is the development and sale of packaged IT products and tools. The third segment consists of the intermediaries, such as IT consultants, system integrators and contract service providers.

The IT spend of any organisation can be seen to provide a hierarchy of benefits. At the higher end are the ideas that generate the competitive advantage and at the lower end is the operation and maintenance of IT infrastructure. Large enterprises have a greater proportion of their IT spend occurring at the lower end of the hierarchy due to their size of operations, and ISVs spend a greater proportion of their IT budgets at the higher end of the hierarchy since IT products are their core business.

In the case of intermediaries, their IT spend is directed towards building their core competence, and hence they spend at the higher end of the hierarchy. Given that no company would like to be dependent on another for the core of its competitive advantage, it is apparent that outsourcing opportunities are a lot easier to carve out of the operating end of the spectrum, and a lot more difficult to carve out of the strategic end.

To contend at the strategic end, critical success factors are capabilities in diverse emerging technologies and domains. To compete at the operating end, critical success factors are scale, size and the ability to manage large projects with a high degree of reliability. It is the absence of both these sets of critical success factors that is compounding the problems of growth of SMEs in IT.

Organisational perspective

Organisational issues can also influence the ability of a company to grow. While many organisations start as extensions of the personas of their founders, there comes a critical juncture in the evolution of most when the organisation has to be looked at as an independent entity. In the past, the reluctance of organisational founders to change the way they looked at their business and organisational design was an important constraint to growth. However, today, with the example of companies like Infosys where the founders have visibly displayed the ability to tackle this type of organisational issue, the organisational challenge is more in terms of the ability of small firms to build the resources and competencies that would enable them to grow and create value on a sustained basis.

The large pool of technically competent workforce in IT companies is a generic resource. Primarily driven by the market opportunities, these companies have built process and relationship capabilities. Having done the initial ground work, very few companies went further and acquired core competencies, which can translate into strategic assets and unique competitive advantage. As a result of being the product of a wave (customers reaching out to them rather than the other way round), SMEs in IT have focused on building a narrow set of client specific technological skills. This shortsightedness has shown up as a weakness in demand-constrained market conditions.

Seen in this light, SMEs have typically formed relationships (with their global customers) that led to their inability to leverage and learn. Leveraging would have meant building domain expertise and specialised skills which would have improved their competitiveness.

Way forward

SMEs in IT need to address three categories of issues; developing differentiated capabilities, converting these capabilities into competitive advantages in the market, and developing a mindset that would help in achieving these.

The next step is to target the distinctive capabilities in relevant target markets. For example, a company specialising in testing and validation services or focusing on the Japanese market can direct its marketing efforts and budgets in a far more efficient way. Leadership approach has to change if you wish to differentiate and leverage it for growth.

Firstly, founders have to recognise the significant changes that have happened in the market place. Secondly, they have to realise that these changes have in turn brought about an urgent need to differentiate themselves from the pack by making strategic choices. Thirdly, the leaders have to realise that by differentiating their offerings, they can in fact create opportunities for new collaborative business models. Fourthly, the leaders of SMEs in IT have to understand that growth is a function of the extent of risk they are willing to take.


In conclusion, it can be argued that while the SMEs in IT have demonstrated an entrepreneurial flair in identifying an opportunity to enter a high growth industry under favourable conditions, their continued success and growth is far from assured. With the industry conditions changing from a buoyant wave of high growth to relatively slow but purposeful growth, SMEs in IT need to demonstrate astute strategic thinking and a willingness to assume calculated risks.

Program Manager, ICT Practice, Frost & Sullivan, South Asia & Middle East