Engagement Models in IT Services

As I interact with my young colleagues at work I get constantly questioned on non-linear models and the challenges being faced by the industry. So I thought of writing 3 separate articles. This is Part 1 of the series on "Engagement Models in IT Services" that sets the context for Part 2 focusing on "Why Traditional IT Services Engagement Models are Failing" and Part 3 "Business Function Outsourcing" discusses the roadblocks that organisations face while implementing non-linear models.

Trust you will find this informative and if you do, please forward this to your colleagues so that they can take advantage of this shared knowledge.

 a) T&M (Time & Material) - Perhaps one of the most widely used models for most consulting, development & testing assignments. Here revenue is directly proportional to number of hours being put by the employees (the more the merrier !) 

b) Fixed Price - Essentially not very different from T&M as it is as linear as any other model except the fact that a vendor has complete flexibility in staffing & managing the project given that most risks are assumed by the vendor. This model is mostly employed wherever business problem can be clearly and unambiguously defined. This is also perceived as a better model than T&M because of the control that vendors have over execution.

c) Fixed Monthly is a hybrid between T&M and Fixed Price where a certain "productivity" is promised every month for a fixed rate. It has advantages over T&M as it ensures constant source of revenue irrespective of holidays & vacations and yet unlike Fixed Price, one is not bound by hard deliverable.

In all the three models above there is a direct linear correlation between revenues & size of workforce (hence called linear models). This puts significant demand on continuous hiring. To circumvent poor availability of qualified talent in the market most large to mid sized organizations mastered the art of hiring, training & deploying talent directly from the colleges. I won't be off if I were to say that Indian IT services firms have mastered this art more than any other industry in the world.

Let's now spend some time on various non-linear models being practiced in the industry. As the name suggests, the primary goal is to break the linearity between revenue growth & employee headcount.

d) License Fee-based - Perhaps this is where one begins to make a start towards nonlinear models. Few questions arise. Why would a services company create products ? In reality it is not the license revenue it is after but it is the services around the product like integration, maintenance, support & operations that is more rewarding. For now let's answer why would a services company even think of products or product based models. Two reasons 1) Product demonstrates competence and helps win related deals 2)  It is a stickier revenue, a huge plus for services company where revenue backlogs are always thin. But isn't services business quiet different from products ? Yes it is and this is one of the reasons why services companies have done a below average job of creating products as most of them have tried running both businesses together, a strategy that seems flawed at the onset. 

e) Platform based Services - This model marries product with services. Most product companies are not setup to provide more than basic professional services to integrate its product in a client's environment. Just like services companies struggle with products, product companies struggle with professional services because of two reasons 1) Inability to effectively create & manage bench and 2) High cost (and hence bill rates) due to lack of de-skilling of complex tasks. This is where traditional services companies do a good job by not only creating & managing bench strength but also build low cost talent pool that can not only provide integration services but also provide operations around it at an optimal cost by leveraging low-cost centers.

f) Gain Sharing - This is an outcome based model that tries to create a WIN-WIN for both clients & vendors. Clients get service usually at an upfront discount in lieu of sharing the gains with the vendors at a later time. My own experience has been that most clients like the idea initially but the proposal usually gets shot down at the CFO/CEO level as it is often considered as a risky proposition.

g) Joint IP Solutions - Clients & vendors agree to jointly work on solving a business problem. Typically most investments are made by the vendor who is able to create innovative solutions by combining client's sponsorship with it's own agility & lower cost. Vendors gain by not only learning domain but creating solutions that can be taken to market. Clients gain because get the required resources to create these solutions which otherwise wouldn't have been possible because of lack of funding & bandwidth.

h) SaaS - Software as a service isn't new and has been existing for last 15 years. In this model clients typically pays per use and are oblivious of what the vendor needs to do to provide a service. Salesforce.com is one of the most commonly used SaaS. This model allows Transaction based pricing.

At this point it makes sense to introduce the concept of Business Function Outsourcing (BFO), which in recent years is emerging to replace individual function outsourcing. In BFO a client outsources an entire business function rather than pieces of it.

Now consider a case where an investment bank decides to outsource a business function around middle office settlement operations for Listed Derivatives. In a traditional model following modus operandi is followed:

1. Engage a process consulting vendor to review the entire operations and recommend possible improvements.
2. Engage an IT firm to enhance/develop IT applications based on recommended process improvements
3. Setup an IT team to make required changes and same or a different team for ongoing maintenance.
4. Engage a QA team to test the changes.
5. Setup operations team to perform day-to-day operations.
6. Setup a production support team to support the IT applications

If you notice there are multiple touch points by the bank with one or more vendors to perform 1-6 above. There is also significant time spent by the bank in managing these relationships and in coordination, prioritization & in oversight.

Alternately the bank could decide to outsource the entire settlement function. In such situations vendor would either use the client's existing application suite or implement an industry known platform or even write a new one (rare). All IT & operations are therefore managed by a single vendor. SaaS & Platform based services are two models that allow complete business function outsourcing. This also helps the clients turn their fixed spend into variable spend as BFO makes transaction based pricing possible.

Headstrong (A GENPACT company) has a platform called Teevra that allows clients to do real-time settlement & allocation of listed derivatives. Teevra even provides connectivity to 15 different clearinghouses. This platform provides "Settlement as a service" to our clients.

Trust this provides a good overview of various models. Do write to me in case you have any feedback or would like to suggest a topic for future.

Why Traditional IT Services Engagement Models are Failing

IT Industry has come a long way since the late eighties. It has almost changed the face of India. We are perhaps the only country in the world that has a good visibility of moving from a developing nation to a developed nation with the backing of a strong services economy. Every other developed nation did this on the basis of manufacturing. Unlike manufacturing, that deals largely with machines, services industry deals with people on both sides of the value chain. IT services, in particular, relies largely on adding new workforce to increase revenues. This industry has grown from less than 100,000 employees in 1995 to over 3.5M employees today. We are already witnessing traditional HR paradigms being challenged as knowledge workers demand individuality whereas at such a scale only a cookie-cutter approach can work !

How relevant are the existing engagement models today and what are the challenges being faced ?

a) Most of the innovation in this industry in the last 2 decades has taken place in improving productivity & margins so it is not surprising that there is very little juice left for productivity improvements. How do you become more profitable in an environment where inputs costs continue to rise ? Linear models leave very little scope for increasing productivity or margins as most gains have already been achieved.

b) Business environment has changed. Companies are looking to focus more on core businesses and trying to variable-ize spending on non-core areas. Even the definition of non-core continues to change. Technology, once considered as core to an Investment Bank, is now being seen as a commodity. BFO is therefore emerging as the new need for managing non-core pieces of the business. Traditional models have no answer to this new need.

c) Industry has matured in the last 2 decades. Factors once considered as differentiators like scale, infrastructure, execution capability & quality of people are no longer considered as differentiators because the gap between the average & the best player in the industry has substantially reduced. How can one create differentiation in T&M & FP models if scale, infrastructure, execution capability & people are found to be alike in almost every organization?

d) As discussed earlier, there is a direct correlation between revenue growth and employee count. As the industry grew there was a higher need for qualified talent and that has already put lot of pressure on both the size as well as quality of the talent pool. Though the number of engineering graduates has become 10 times from 50,000 to 500,000 in the last 15 years, Academia & government continues to be very stressed to meet the ever growing demand . This imbalance in demand & supply has also resulted in increase of labor costs. Somewhere this linear cycle needs to be broken.

So as you can see linear models are falling flat to the changing business environment. Various nonlinear models like Gain sharing, SaaS & Platform based outsourcing rely heavily on IP and institutionalized domain knowledge rather than on individuals or on operational efficiency.

Our future depends on how quickly we are able to make a shift towards building IP & foster an environment of innovation else the industry will die within the next decade.

I also suggest you read critical analysis on the IT industry and Business Function Outsourcing

Business Function Outsourcing - Close yet very far!

IT Services Industry is moving fast towards Business Function Outsourcing (BFO). Read Why Traditional Models are failing to know what is driving this change. This is not a new concept and has been existing for a while but the industry has been very slow with its adoption. What is holding the industry back ?

Reasons behind Slow Adoption

a) Lack of Intimate knowledge of the Client Business. Industry has so far focused on achieving operational efficiency and building infrastructure and scale. The need for learning client's business was never felt that urgently because there was no dearth of business and the challenge was sheer execution. It's only when the pipeline has dried in the last 3 years is when the industry is beginning to realize its oversight. We have been a victim of our own success!

b) BFO requires confluence of Consulting, Product Development, IT & Operations - Those who have been in the industry know that these four businesses are very different from each other. Most IT Services organisations run consulting, IT & operations as separate horizontals and in silos. Bringing them together, therefore, isn't something that can be achieved overnight. On top of it, integrating Product development is even tougher. Why ? Cost points, revenue model, people policies, hiring practices, quality of infrastructure & leadership required for running these businesses is very different from each other. There are numerous examples in the industry where this confluence has been attempted and has failed.

So the trick is how to build strong "institutionalized" knowledge of the domain and bring consulting, product development, IT & Operations together to perform full business function outsourcing. 

Lot of companies are trying to solve this problem but unfortunately most seem to be making similar mistakes because we are all trying to "tweak" our proven models rather than unlearning what we have learnt !

What we have learnt so well is:

a) Build scale by institutionalizing our learning & processes
b) Drive operational efficiency in every aspect of the business
c) Utilizing lower experience workforce to do complex tasks by de-skilling the job

It's time to perhaps unlearn some of this, if not all of it. Building capability & competence, a key requirement for BFO, is neither a scale game, nor you can succeed if the goal is operational efficiency at the onset nor you can use inexperience or "bench" workforce. Running IT & Operations, which is the second requirement for BFO, is very well known to the IT industry. How do you, therefore create an environment for innovation & creativity and marry it with scale? Whereas latter is Industry's sweet spot, the former is where it has struggled, an area product companies thrive at.

Looking at the failure rate across, it is obvious that something isn't right.

Common mistakes being made

1. One of the biggest issues I see is that most firms haven't changed their "process" for creating competence and hence have used existing business support groups, most importantly HR & Recruitment. This complex confluence of four different mindsets & businesses requires a grounds-up HR & Recruitment organisations, preferably coming from a product company rather than a services company as existing services paradigms are severely lacking for this new reality.

2. Another change that is a must but often over-looked is the need to establish a strong Take-ONLY relationship in which this group is entitled to draw the required talent it needs from the rest of the organisation but its own talent is unavailable. I have seen that the moment you create a differentiated group in a services company, more often than not it gets absorbed in daily rut because of revenue & delivery pressures. This alone is capable of killing any such initiative.

3. It is not possible to build products & platforms from grounds-up because it will take forever so this business has to be bought. Be it platform or product companies or even buying-out IT platform from Tier 1 banks to get started. My experience is that most public companies get bogged down in valuations and impact on bottom-line & street reaction rather than focusing on the fact that if we do not change we will be extinct !

At the end building true capability (not trained capability) and creating products & platform based services business for BFO is a very different beast that requires IT services firms to unlearn what they have learnt since last 2 decades. Perhaps this is best run as a separate entity that can draw whatever it needs from the parent without giving anything back.

Product creation or building Platforms and real domain capability is diagonally opposite to running a well oiled services business. No wonder a group of product companies recently broke away from NASSCOM to form its own consortium called iSPIRT. 

IT Industry - A critical Perspective

Graduating from NIT Kurukshetra and entering into the corporate world in 1994 looked like a very elite milestone during those days. Knew that I was part of only 50,000 successful engineers to do so in India. If you are graduating as an engineer today then you are one among 600,000 engineering graduates being churned out and more than half, irrespective of your primary discipline, will get absorbed in the IT industry.

No wonder fresh graduates entering the (IT) industry find themselves to be part of a herd having to grapple with 9 hour work rules, dress codes, strict adherence to processes, online trainings, under-staffed HR and under-pressured recruitment and resource management groups. Recently I was at an IIM for a lecture on the industry and wasn't surprised to hear severe discontentment among the students who worked with IT companies and were forced to pursue their MBA with an intention to switch to an alternate career. Reminds me of the infamous 'Cattle class' comment Shashi Tharoor once made !

While introspecting our journey in the last 2 decades, I find that there are two areas where we went wrong:

1. We, as industry leaders, have fallen prey to our own success. According to management theory, the best time to change is when you are down-under! Does this imply that when times are good there is no need for a change? It seems so because when the industry was riding the wave of labor arbitrage in the nineties, I wonder if any of us was thinking about what happens when the tide ebbs. Perhaps that was the time for us to work overtime to build strong domain capability whereas we  were all busy making ourselves operationally efficient and improving our profitability. As a result we continued to rely on traditional outsourcing models that are highly dependent on individuals rather than capability. So the only way we have learnt to increase revenue is by increasing people. Top 5 IT services companies today employs over 800,000 professionals up from less than 8,000 only 20 years back!

2. Okay, so we did not devise alternate models that were competency based and waited for too long but then why did we have to resort to 'Cattle Class' policies ? As the industry scaled we were in dire need of leaders who were expected to lead and not manage. Let me tell you a story that will perhaps explain what I am trying to state. I know someone, let's call him Prasad,  who joined a mid-sized IT services company and was greeted by the MD with a rose and a personalized message on day one. Of course there were just 200 people then and as the unit scaled to 2000, not only was Prasad expected to do just the same as his MD did but should have passed on that culture to his next level. Unfortunately the tradition stopped soon after as Prasad became busy running his own unit and never understood the importance of building a culture. Prasad's MD couldn't see the culture die so had no option but to devise a process of welcoming new employees by sending them a rose in an email ! Culture was "stabbed" that day.

Couple of years back I was in an HR conclave attended by the biggies of the industry and in one of the sessions HR heads from various companies debated passionately on how they have streamlined induction training and one HR head stood up and proudly announced  how they have completely 'automated' the 'process' where induction program is now video based with no 'human intervention'. We continue to stab the dead corpse!! Take 9 hour rule for instance. In any company of decent size, it is estimated that about 15-20% employees abuse flexibility so when companies devised 9 hour rule  it looked very fair and justified. While managing scale, one often relies on the front-line manager to uphold organization's culture & traditions but since we haven't had the time to groom them so no wonder there is misalignment & mistrust in the system. Policies have replaced what culture was doing before or is supposed to do.

So why didn't we create a culture by aligning front-line managers? That has to do with how we have rewarded managers. Today you can barely count on your fingertips the number of companies who disproportionately reward managers and leaders for imbibing culture and grooming leadership. We have chosen to rather reward on P&L accomplishments. The results are in front of us. We are operationally best in class but continue to struggle with emotionally relating to our employees, whom we fondly call "resources".

All is not lost, we need to focus on two things for course correction and both are easy said than done:

a) Continue to spend disproportionate time in innovating and

b) Celebrating those who build cultures and groom leadership.

Try doing this and we have a chance of making the "Cattle Class" tag disappear and continue to lead the outsourcing industry in the world.