Analysis of Off-Shore Growth Rates

ANALYSIS OF MARKET GROWTH FOR HISTORICALLY ON-SHORE AND OFF-SHORE SERVICE PROVIDERS March 2014

Stratevum is a research and advisory firm that works with management teams, investors and boards

of directors to transform technology companies into high growth, high value businesses. We focus

specifically on the data center, cloud, managed services, IT outsourcing, BPO and SaaS sectors.

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HfS Research recently published a table depicting the four year revenue growth rates of historically on-shore and

off-shore outsourcing providers. From 2009-2013, off-shore centric providers such as Cognizant, TCS, HCL, Infosys

and Wipro have demonstrated an average revenue CAGR of 18.9%, while on-shore centric providers such as

Accenture, Capgemini, HP, IBM and CSC have delivered an average revenue CAGR of just 1.3% during the same

period.

FIGURE 1: Four Year Revenue CAGR of Historically On-Shore and Off-Shore Service Providers

Off-Shore Centric Indian Providers

Revenue CAGR 2009-2013

On-Shore Centric Traditional Providers

Revenue CAGR 2009-2013

Cognizant 28.2%

Accenture 8.2%

TCS 20.8%

Capgemini 3.5%

HCL 19.5%

IBM GS 1.5%

Infosys 15.0%

HP ES -1.7%

Wipro 11.0%

CSC -4.5%

Average 18.9%

Average 1.3%

SOURCE: HfS Research Ltd., March 2014

As a result of the outsized growth, the off-shore providers have doubled their market share over the last four years

and now capture 7.0% of total industry spend on outsourced services, compared with 3.8% market share in 2009.

Its worth noting that the market share of the traditionally on-shore majors has remained essentially the same,

which implies that off-shore majors are growing market share by capturing a greater share of new opportunities

and taking business from second-tier on-shore providers that have not developed off-shore capabilities.

FIGURE 2: Market Share of On-Shore and Off-Shore Majors 2009 v. 2013

2009 2013

SOURCE: HfS Research Ltd., March 2014





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Its no surprise that off-shore centric providers have outpaced the growth rates of traditionally on-shore service

providers. STRATEVUMs Six Levers of Revenue Growth provides helpful context in understanding the dynamics

of the overall industry. The framework is based on the premise that every strategy and tactic employed by a

company is aimed at pulling one of six levers that affect revenue growth from increasing the number of

opportunities in the sales pipeline to reducing attrition and price compression from the installed client base.

FIGURE 3: Six Levers of Revenue Growth

COMPONENTS OF STRATEGY LEVERS OF GROWTH

Market Size and Focus Increase the Sales Pipeline

Geographic Expansion Distribution Model

Increase the Conversion Rate Opportunity Qualification Incentives and Compensation

Increase Revenue Per Sale Client Engagement Model Sales Process and Tools

Capture Greater Share of Client Spend Market Awareness Competitive Differentiation

Decrease Client Attrition Products and Services Pricing Strategy

Reduce Price Compression Product Bundling

Source: Stratevum Advisors

Over the last decade, virtually all of the growth in the outsourcing industry has been led by the migration toward

offshore resources. For the offshore majors, this represented a new opportunity to tap into an emerging market

where they had very little existing exposure to client attrition ( ) or price compression ( ). As a result, they

were able to devote their resources toward building a distribution model ( ) to capture the growth in off-shore outsourcing. Once they had established the distribution model, they expanded their service portfolios to capture a

greater share of client spend ( ) and increase revenue per engagement ( ). The combination of high growth in a nascent market, product line expansion and immunity from attrition and price compression has enabled the off-

shore majors to achieve strong double-digit growth rates for the last several years.

The traditional on-shore providers also recognized the opportunity for growth through off-shore outsourcing, and

companies such as Accenture and IBM began to develop off-shore delivery capabilities of their own. IBM now

employs more people in India than almost all of the off-shore majors. However, while offshore outsourcing

presented the traditional service providers with a new revenue stream, it also accelerated pricing pressure from

their large base of existing outsourcing clients. Thus, gains in new revenue were partially offset by revenue erosion

from existing clients that migrated to offshore delivery models at a lower price.





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While price compression largely explains the delta between the off-shore providers and the traditional on-shore

companies, it doesnt adequately explain the difference in growth rates between off-shore providers such as

Cognizant, which demonstrated a revenue CAGR of 28.2% over the last four years, and other off-shore providers

such as Wipro, which grew 11.0% annually during the same period. Both companies participate in the same

market, targeting the same client base with similar services delivered in an offshore model, so why has Cognizant

outperformed the rest of its offshore peers?

The common narrative is that Cognizant has invested greater resources in sales and marketing to drive a higher

revenue growth rate at the expense of short term margins. This is partially true. As Figure 4 depicts, the

companies with the highest growth rates are the ones that have invested the highest percentage of revenue into

SG&A.

Figure 4: SG&A as a % of Sales vs 4 Yr Revenue CAGR

Source: Stratevum Advisors. Information taken from public financial filings.

While it is true that the companies that have invested the greatest amount of resources in SG&A have delivered

higher revenue growth rates, the larger picture is more complex. As Figure 5 demonstrates, not only has Cognizant

invested the greatest percentage of revenue back into sales and marketing, the company has also consistently

achieved a higher return on its sales investments compared with other off-shore majors.

28.2%

20.8% 19.5%

15.0%

11.0%

19.2% 18.7%

15.8%

11.5% 12.4%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

Cognizant TCS HCL Infosys Wipro

Revenue CAGR 2009-2013 SG&A as % of Sales





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Over the last four years, Cognizant has realized a 1.5% revenue CAGR for every 1% of total revenue invested in

SG&A, while Wipro has realized just a 0.9% revenue CAGR for every 1% of revenue invested in SG&A. Put another

way, Cognizant has achieved 60% greater productivity from its sales force when compared with Wipros

performance over the same period.

Figure 5: CAGR for Every 1% of Revenue Invested in SG&A


Here again, the answer lies in the way companies deploy resources to drive the Six Levers of Revenue Growth. It is

typically more efficient to grow revenue from the existing client base vs. chasing new logos, especially when the

existing revenue base is not susceptible to significant attrition or price compression. Over the last few years,

Cognizant has made an explicit effort to deploy an onshore client engagement model aimed at building long

standing, deep relationships with its existing client base. The high touch, solution oriented approach has

contributed to Cognizants ability to outperform its peers.

Perhaps the greatest misconception about the fastest growing companies is that they are doing it at the expense

of operating margins. The reality is that the companies that have invested the most in SG&A are the ones that

have the lowest delivery costs; therefore, they can afford to spend more money on sales and marketing and still

achieve healthy operating margins.

Figure 6 demonstrates the Cost of Revenue and SG&A as a percent of total sales for each of the five majors. For

companies such as Cognizant and TCS, Cost of Revenue is less than 60% of sales, which enables them to put

greater resources into SG&A. Conversely, Wipros Cost of Revenue is nearly 70% of sales, which challenges the

companys ability to invest in sales and marketing and maintain industry-level operating margins.

1.5%

1.1% 1.2%

1.3%

0.9%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%






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Figure 6: Operating Margins (Revenue Less COR and SG&A) for Off-Shore Majors


Going forward, Stratevum expects the off-shore industry to continue to expand, however, we believe the growth

rates will narrow between the off-shore vendors and the traditional on-shore providers. This is due to several

factors:

1. Lower exposure to price compression for traditional providers. For the last several years, the traditional

on-shore providers have experienced substantial price compression as their existing client base adopted

off-shore outsourcing to lower costs. The traditional providers are still exposed to price compression, but

we believe it will be at a lower rate than prior years.

2. Higher price exposure for off-shore centric providers. The off-shore majors have now developed a sizable

client base, and we expect those clients to seek price concessions upon renewal.

3. Shifting strategies of competitors. Companies such as Wipro have made a concerted effort to lower

operating costs to improve margins and fund investments in sales. Companies such as Cognizant will face

greater competition from other off-shore majors, as well as traditional on-shore providers.

4. Lower industry growth rate. The off-shore industry has begun to mature, resulting in greater competition

for new engagements. We believe the maturing industry and greater competition will result in greater

pricing pressure on new deals.

21.3% 27.5% 19.4% 25.8% 18.0%

19.2% 18.7%

15.8% 11.5%

12.4%

59.5% 53.8% 64.8% 62.7% 69.7%


Other SG&A as % of Sales COR as % of Sales

Average: 22.4%

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Analysis of Off-Shore Growth Rates