Information Technology Industry has been around since 1970s when a mini computer was not really mini in size! Fast forward to 2017, a lot has changed and it will keep on changing in future as well. Such is the nature of this industry. Most of the industry leaders are not listed on Indian stock exchanges, rather they are listed on American stock exchanges. As an investor, you might be thinking how to ride such trends & possibly make most of the listed companies in Indian stock exchange? Additionally, there are visa issues & a general downtrend in all IT stocks. Allow us to explain in simpler language as we do at AI. It’s a little longer article, so we are publishing it on weekend. Happy reading!
In order for us to understand the dynamics and its impact at macro level, let’s go a little bit in the past. I know you may not like History but I will keep it to bare essentials only.
During pre-1990 era, Information Technology companies were big but very few. There were IBM, Microsoft, Apple but not much of presence of TCSs, Cognizants or Accentures. The major reason was because the industry was new & economy was mostly paper based. Adaption was also slow due to lack of information portability and robustness. Most systems were running in isolation with pre-loaded applications. Think of it as having a smartphone where all applications are factory installed only. This smartphone size was equivalent to a wardrobe which sits in isolation at a corner of your house. The utility was that it can store all your clothes in one place, otherwise your clothes will be all over the in your home.
During pre-2000 era, while major players were busy in creating new products (Microsoft was releasing new version of Windows), there was a bunch of new IT companies who did not have a breakthrough Product but they had capabilities to create Applications using popular products. Enters the age of TCS, JD Edwards, EDS, Infosys, etc. By this time, the IT industry’s market pie had grown much bigger and many companies could nibble chunks of it. Compared to our smartphone analogy, now you had players who can build custom applications for your smartphone but these applications were still cumbersome to use in terms of interface.
Enters 2000 era, the pre & post Y2K . This was a scary time for a lot of companies using information technology. The problem was that all the custom softwares were written in only two digits representing a year. So post year 99, there would be year 00. This would create issues with all the records as dates would go haywire. System would not be able to recognize whether it is 20th century or 21st century. This created a unique and huge opportunity for all service based players (TCS, Wipro, Infosys) to get bulk orders and change all codes where such problem exists. Result was a huge jump in revenue growth & corresponding jump in stock prices. Yay times for investors.
Post-2000 era until 2010. During this era companies like Oracle & SAP sensed an opportunity of bridging a gap that has been existing all along until this time. The gap was lack of company wide unified software. This is called as ERP (Enterprise Resource Planning). To compare it with our smartphone analogy, you now have different applications on your smartphone but each application does not know what other application is doing.
So if you have whatsapp, it can not access your contacts. So every time, you have to manually add a contact in your whatsapp contact list as well. Same for all other applications. It was a big gap which impacted efficient use of technology. What SAP & Oracle did was that they created their own software where application & functionalities were connected to each other. During this time, the service based companies like TCS changed their business model and started servicing these new unified software from SAP & Oracle. This resulted in more revenue since most of the companies were heavily reliant on IT systems, so they had to migrate from legacy applications to these new unified applications. Again, yay times for investors.
Post-2010, enter the new age of Cloud & Digitization. Between 2000 and 2010, the network speeds jumped many folds which enabled people & companies to become more connected with each other using Facebook, Twitter or Orkut (RIP!). Sensing this, IBM, Amazon, Salesforce.com started offering IT systems using cloud models. Cloud is nothing but a network of IT systems connected with each other from where you can get what you want at a cheaper price. This spelled trouble for traditional SAP & Oracle models since these system were not on cloud but on IT systems sitting within company controlled offices. By this time, Indian IT companies were too reliant on earnings from ERP eco-system like SAP & Oracle. Also they have grown in number so much that getting 20% more revenue year on year is a challenge. Again comparing it with our smartphone analogy, now you have Google playstore or iTunes from where you can get applications created by anyone in the world. You do not need to be tied to a single company to buy all applications, it can be anyone & it can connect with any system.
Market dynamics for IT industry has changed, now customer no longer visits physical office but they visit facebook pages very often. Consumer has become digital which compels companies to also adapt digitization. So, companies are closing their street shops & opening up digital shops. This is going to benefit firms like Facebook, Whatsapp & Google since they have customers with them. So what happens to traditional IT players? Well, the answer is that they have to adapt to digital & cloud based services as well. Also, big players like IBM, Microsoft, SAP, Oracle are moving & launching new products which have cloud based offerings & have digital capabilities (SAP Hana, Microsoft Office 365 & IBM Watson). This shift is currently taking place as I write this article.
Coming back to the important question for an Indian Investor, what will be the impact of this shift & how to handle it? It is mostly Indian IT companies which are listed on Indian stock exchanges & we do not have Apple or Microsoft listed with us. So, let’s analyse impact to Indian IT players like TCS, Infosys & Wipro. So far, you will notice that Indian IT companies are not innovating anything new, they are simply into servicing new technologies. This means most of IT staff has to be retrained on digital technologies which does not look easy considering their size and revenue numbers (in billions). By the time they make this transformation, there will be a sure dip in revenue. What we fear is that a large turn around time will not work in favor of large IT players. The small & medium IT players like Persistent, Cyient, 8kmiles will eat away a lot of pie by the time large IT players set their teeth in. So for the time being hold your investments in large cap players.
There will be two kinds of sections emerging from here. One will be Platform Providers who will enjoy huge moat with firm customer base (Google, Facebook, Amazon, Microsoft, Salesforece.com, etc). The other section will be Service Providers which will be a highly fragmented industry with a lot of competition. This pie is going to be distributed into a lot of small & mid sized players until the time consolidation takes place with some new trend. One thing is for sure that large IT players are not going to be next multibaggers unless some of them transform themselves more rapidly than usual.
At AI, we keep a close eye on changing dynamics in IT industry. We have recommended very few mid sized IT companies which are highly focused on servicing digital solutions with proven track record. For details, click here.
PS: With slump in IT industry, there is an impact on job market, consumer spend & overall economy. AI will cover it in future reports. Stay tuned.
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