Revealed: Why Indian Outsourcers Are Buying into Verticals

Large Indian outsourcers have been buying US-based niche vertical industry specialists, and experts expect the trend to continue. The acquired firms are helping expand opportunity in high margin engagements, while also building the human resources needed for long-term growth.

“For these big players, acquisitions will increase their vertical footprint and be a big differentiator in the next five years,” says Stan Lepeak, Head of Management Consulting Research at KPMG. “This is true whether we are looking from the perspective of investors, customers, or of clients as strategic partners.”

A good example is Cognizant’s recent decision to acquire US-based digital video solutions firm Itaas. Cognizant, founded by Indian nationals but now headquartered in the United States, believes that the move will help it shift deeper into the telecommunications and media verticals, with access to major companies like Time Warner Cable and Comcast Corp. From a larger market perspective, purchases like this don’t surprise Lepeak.

“We have seen this trend for a while, but it is starting to accelerate,” he says. “The traditional services that multinational are providing out of India, things like app development and management, are becoming commoditized. And as labor rates rise, arbitrage is not a sustainable strategy – the margins aren’t there.”

But does that mean the margins are in niche verticals? Yes, but not to such an extent that there will be an immediate impact on the bottom line. When making the Itaas acquisition, Cognizant stated clearly that it would “not have a material impact on Cognizant’s 2014 revenue”. Nonetheless, in making acquisitions Indian firms are saying they need to do more than push around expertise in the C-suite.

“It was common a few years ago for Indian firms to hire executives out of industries,” says Lepeak. “This was true with IT, but particularly so with BPO. There was a more specialized need, and we were seeing hires out of big consultancies to add industry expertise. The result was that the big Indian firms could talk a good game in, say, banking and healthcare, but they were still delivering fairly generic services.”

Breaking the Mould

The Cognizant purchase of Itaas is unusual in that most Indian outsourcers have been building vertical market expertise in areas where regulatory requirements have provided hurdles, yet where there is plenty of money still on the table – namely health sciences and financial services.

“This is where they can develop capabilities in strategic application design, and where an understanding of the regulatory framework is crucial,” says Lepeak. “The buyers are looking beyond the basics in these markets, but that means that the Indian outsourcers are also then going up against some big players.”

This explains why, for example, Genpact announced last month that it plans to acquire Pharmalink Consulting, a provider of regulatory services in life sciences. Building domain expertise by bringing in a complete workforce, and an established client base, is the kind of extra push a large outsourcer needs if it wants to take on the likes of IBM, Capgemini, and Accenture. But getting these people to stick around may, in fact, be the biggest challenge.

“The Indian firms have a mixed success integrating acquisitions of western firms,” says Lepeak. “And if the people leave, then the buyer loses a lot of value in the acquisition. Tucking in a smaller niche vertical could be more practical. This is preferable to the revolving door, where senior executives take their money and walk.”

Choose Wisely

This comes as Genpact has also announced that it will more than halve the number of verticals it will focus on. The strategy is to grow in those areas where there is the most opportunity, and not to spread things too thinly across verticals. The company’s 23 verticals have been reduced to nine, with the lion’s share of emphasis on financial services and manufacturing, which make up 85 percent of Genpact’s business.

“The larger Indian firms are getting better at this,” says Lepeak. “Their ability to get it right in a vertical, and to keep the expertise around, will be a contributing factor in terms of what will separate a top and second tier player.”

Gone are the days when the differentiator was simply who could spin up technology faster. Genpact, for example, has brought in management consultancy firm McKinsey to help it chart its path, part of which includes a major reduction in point solutions. The result is that it won’t be tying up resources trying to win smaller battles, and can focus on getting deeper into the more lucrative verticals.

Global Shifts

There is a geographic play as well, with Genpact pulling back somewhat from China, and Cognizant hoping to reduce its reliance in the US market by building resources in Europe. This has been exemplified by Cognizant’s acquisition of the Hamburg-based C1 Group of companies two years ago, and by its more recent purchase of France-based Equinox Consulting.

“To accelerate growth, the large Indian outsourcers will continue to have to make acquisitions,” says Lepeak. “In the past they could cast a broad net with a few clients, but it is harder to grow beyond that. Having more nearshore resources is beneficial, but this has to move beyond ‘faster, cheaper, better’ to address middle office requirements in a given vertical, and adhere to the rules and regulations.”

And as the larger Indian outsourcers look to deepen their vertical market expertise, others are looking to pick up horizontal opportunities in areas that are not fully tapped out, such as mobility and security. One example is India and US-based Kellton Tech Solutions, which just bought New Jersey-headquartered eVantage Technologies.

“If you look at basic technology requirements like maintenance, management, and integration, those are cross industry,” says Lepeak. “But then all of these outsourcers will need people who know the ins and outs of a given industry – and in that regard having the right security folks will be key.”