Bridging the market cap: can mid-caps join the big league?

Abstract

According to NASSCOM, India represents 65% of the global industry in IT in an addressable offshore market of $ 300 bn (inclusive of the BPO sector). Over the past decade, this industry has entered its growth phase and as expected in this phase, there is an emergence of an industry structure. The three-tier structure has a top-tier of four to five organization characterized by large scale, high capitalization and high growth rates. The middle-tier companies or mid-caps are companies that have large capitalization but with lower market value and medium scale. The low-end companies are usually niche companies catering to specific areas and are low on scale. This paper analyses six mid-cap companies against a benchmark top-tier company in an attempt to determine why these long standing companies have not been able to join the big league on parameters of revenue growth, profitability leading to increasing market capitalization, despite being in the growth phase of the industry. Mid-cap companies are usually characterized by revenues from one are two large customers, specialization in one or two verticals mainly with a technology focus. They are constrained by the lack of scale and resources and importantly, face intense competition from the big players. Therefore, their strategies are often around survival rather than aggressive growth. While their key strengths involve flexibility and responsiveness, the areas that need direct attention to help them get out of this rut are good practices in Revenue Management and Cost Management coupled with risk taking abilities. Revenue Management in the smaller mid-cap companies is seen as pure inflow reporting. Accountability for efficient practices in Marketing and Sales, Pricing and effective use of resources (assets and capital) are often not scrutinized by management. A comparison with the benchmark company, Infosys, demonstrates that the ROA and ROCE of these companies are in some instances, 50% lower. Therefore, areas such aspiring, funnel management and revenue per customer need to be given focus during strategic decision making. Cost Management is a function of how variable and fixed costs are managed per unit of production. In the IT services industry, the value chain extends from the time a sale is made, to the software development activities done onsite and offshore, the administration activities and finally post-delivery warranty activities. Again, a value chain analysis of costs yielded predictable results with the market leader Infosys, returning 32 paisa to the rupee as value add and mid-rung companies adding anywhere from 8 - 12 paisa to the rupee. Clearly this difference is due to inadequately defined cost structures and their tracking. There is good opportunity to correct this situation through more accurate segment reporting and cost analysis. Strategically, the mid-cap firms are moving towards differentiated positioning in the market. However, there is very little evidence of plough back of earnings into investing for intellectual property development, product-driven services or innovation to implement this new positioning. These trends can only be reversed if the value chains is reviewed from dimensions of cost, geographies, revenues and product mix. Also, specific reporting and tracking of the company's ongoing performance through stricter management control systems is a requisite to better internal controls. Innovative ways of revenue-stream building and customer relationship are vital to the future success of these companies.