A Brief Introduction to the Indian IT Industry

A quick review of the essential figures reveal that with the year ending 2004-05, the Indian IT industry recorded a growth of 33 percent, reaching an annual turnover of Rs. 124,039 Crores. Although the top 5 Indian players, on an average, have been growing at a healthy 42 percent, their combined contribution is less than 25 percent of the entire industry.

Introduction to Various Theories and Their Linkages to Our Industry

As per the strategic literature, the Indian IT industry could be trapped in what is known as “the red queen effect”. The red queen effect refers to the red queens’ advice in Lewis Carroll’s Through the Looking Glass in which she says, in order to stay in a (competitive) place you have to run hard, whereas to get anywhere you have to run even harder. Such an effect can prove detrimental with the conditions such as: new players entering the market, limitations in improvement and intense head to head competition (as rivals in the industry have adapted and become stronger competitors).

First Symptom – New Players Entering the Market

The condition of many players entering the market, a prominent characteristic of red queen effect, can be explained through conventional economics. When players with homogeneous offering and similar prices inundate the market, the competition is said to be perfect. Being able to do something, which the rivals cannot is the definition of competitive advantage. Thus, the entries of many such players occur due to the lack of substantial competitive advantages by the incumbents so as to deter entry of new comers. With lack of barriers to entry, the newcomers would pour in until the extra-ordinary profits (which are profits over the sum of opportunity cost and normal profits) are reduced to normal profits. A similar scenario could be associated with the Indian IT industry albeit with certain exceptions.

The Indian IT industry could be better defined by the term “polyopoly” coined by Dr.Taikobo Onoda in the 1960’s. The basis of the classification is that the market leader has less than 26.1 percent of the market and each company is within 1.7 times the market share of its nearest rival. In such a case, the market is unstable with a strong possibility of abrupt shifts in the company ranking. The numbers associated with the market share arise from Onoda’s investigation on 3:1 law and reliance on Lanchester equation.

In 1914, F.W. Lanchester developed his famous equations, which have been made relevant to business by Nobuo Taoka. The basic approach is to mathematically equate the loss rate of market share taking into consideration the market share of the competitor(s) and the ability with which the competitor(s) can either sustain or increase its share.

Another useful law, that’s worth mentioning, is 3:1 law. The latter with reference to a battle in the military context states that in order to vanquish a competitor, who has established a defensive position; there must be 3 times as many troops needed as that of the incumbent. However, for the business context, the troops can be surrogated by market share. Thus, the figure of merit 1.7 times the market share is achieved by applying Lanchester equation on 3:1 law.

With reference to the market share of the top Indian IT players- TCS leads the industry with a market share of 7.8percent. Infosys and Wipro closely follow with market shares of 5.5percent and 5.4percent respectively. From the above data, its evident that the market share of TCS is 1.4 times that of Infosys and Wipro.

Although the figure of 1.7 times the market share is obtained from the application of Lanchester equation, its significance is revealed by another theory named range distance theory. The latter indicates that if the gap of 2 companies in a market is less than 1.732, then the leading company will not be in a safety status and hence there will be a threat from the following company. The competition, in such a case, becomes intense and rivalry increases.

Although the Indian IT market is swarmed with many players, the top 5 players on an average enjoy an operating margin of 22.8percent. Such a paradoxical situation, at least theoretically, begs the question regarding the sustenance of their profitability. Essentially these profits under question will be an outcome of the competitive scenario that would unfold with maturing markets and declining growth of industry.

Second and Third Symptoms: Limitations in Improvement and Adaptation of Rivals

With lack of substantial entry barriers or forces that would deter entry in the Indian IT market, it will be useful to analyze the competitive advantages of the incumbents. As per the strategic literature, the 3 most potent competitive advantages are advantages from supply (ability to produce and deliver goods at a cost advantage), economies of scale and customer captivity. In their book, competition demystified, Bruce Greenwald and Judd Kahn, suggest that a combination of any two of the above mentioned advantages might help an organization to a great extent against competition.

A company can realize the cost advantage when the company has an exclusive access to raw materials or through the know-how or with the use of proprietary technology. The above advantage, in the context of Indian IT industry, seems to be weak. This may be attributed to the lack of technological superiority, with almost all the offerings of one company being easily replicated by others in the industry. Thus with a limited scope for improvement, rivals tend to adapt easily to the competition.

The Indian IT industry, unlike that of China or Brazil is predominantly service oriented, with less contribution from the product space. Hence, majority of the revenues come through repeat business with the existing customers. Customer captivity, for the top guns, is then a major advantage.

Together, the economies of scale (EOS) are enjoyed in a limited and relative context by the frontrunners of Indian IT industry. The EOS, depend not on the absolute size of the dominant firm but on the difference between it and its rivals, that is on market share. In context to the Indian IT industry, there are 2 limitations in realizing the EOS. First, a growing market does not help realize EOS to a great extent. Second, the industry is fragmented and the players are handicapped without a substantial difference in market share. Thus even the major players have comparable average as they operate on comparable scale (adaptation of rivals)

Future Outlook Of The Indian IT Industry

Hence, with a moderate degree of competitive advantage working to their favor, the top Indian IT companies can make inroads against the weaker competition. Put differently, though there may be new entrants it is certainly impossible for them to create another TCS, Infosys or Wipro. However, the competition from global players such as IBM and Accenture is accelerating at a great pace. The comparative advantage of low cost (highly skilled) labor that the Indian IT industry had been enjoying over other countries is now getting eroded with global MNCs setting up their shops in India. The rule of thumb in such a scenario would be to remain competitive and become operationally efficient.

With greater efficiency there will be some respite from the aforesaid conditions of red queen effect. The combination of EOS and customer captivity can help tier the competition and help the rivals of one tier fight effectively the rivals from another tier. The tier-1 companies, for example, can collectively deter the entry of another player from tier-2 into their group. Michael Porter defined the formation of groups or tiers within industry, in his breakthrough book competitive strategy, as strategic groups and the mobility barriers as the forces that deter entry of players from one group to another.

Apart from organic growth, Indian IT companies may also pursue the mode of inorganic growth. The trend has already started with few acquisitions been made by the biggies in the recent past. With industry maturing, there would be more consolidation activities to be witnessed. In such a case, only few players will concentrate the market.

REFERENCES:

Escaping the Red Queen Effect, European Management Journal Vol. 23, No. 1, pp. 37– 49, 2005, SVEN VOELPEL, MARIUS LIEBOLD, EDEN TEKIE, GEORG VON KROGH

COMPETITION DEMYSTIFIED, Bruce Greenwald and Judd Kahn

Competitive Strategy, Michael Porter

Death of Competition, James Moore

Lanchester’s Law and its application in war and business: Han Chih Lee

Lanchester Redux by John Schuler Dataquest

British military theory finds favour among Japan’s business, Dr.Nigel Campbell, Financial Times