Harnessing Innovation, Reverse Innovation and Bottom Of the Pyramid to build a firm’s competitive advantage

Running a Fortune 500 company as its CEO is arguably much more complex than piloting a Boeing 787 Dreamliner or an F-16 Jet for that matter. Enter the cockpit of a fighter plane and you will be amazed by the myriad arrays of display panels and complex control systems. I have been talking to multiple customers in various industries and the sentiment is same across all the customer segments. Industry executives that I have talked to echo in unison that “Embracing Innovation” is a key pain point for today’s CEO as the organizations become more and more complex due to interdependencies with a number of moving parts and the interactions of these moving parts often lead to unpredictable outcomes. Innovation is one key enabler that will help break down the complexity barrier and helps simplify the internal workings of an organization as well as its relationships with its customers. Innovation can play a key role in making things easier and simpler starting from the internal business processes to the customer and supplier facing processes as well as in launching ground breaking products and solutions for the end customers thus helping the firm remain ahead of the curve.

Companies world over pare down their Innovation and R&D Budgets in times of poor global macro-economic conditions and try to improve their bottom-line thus getting inextricably caught into what is called as an “Acceleration Trap”. Many firms across the world fare very poorly when it comes to explaining the investments in “Innovation” to the bourses and more often than not get beaten up on their stock prices. Innovation needs a long term approach and “Incubations” by their very definition need a reasonable gestation period. Firms need to adopt a portfolio or a venture capitalist mindset in their approach to innovations. All the innovation investments may not lead to successful product launches and similarly the entire R&D endeavors may not see light at the end of the tunnel. However if the probability of failure is encapsulated in the ‘innovation portfolio’ model then one will start looking at the entire concept of innovation in a different light. None know this better than the pharmaceutical companies who invest large amounts on innovation on a basket of initiatives hoping that atleast one will become a blockbuster hit.

The board rooms of Fortune 500 companies are now abuzz with the term, “Reverse Innovation” and are looking at ways to leverage its potential to aid the growth of the firm. Now-a-days the mantra is to carry out focused R&D efforts targeted at creating products that are specially designed and adapted to the emerging economies. The needs of the emerging markets are different and so are the price points and value expectations of the consumers in the emerging markets. The approach mentioned above needs innovations and inventions in core technology areas such as material sciences, electronics, fluid mechanics, power systems and the like. Consider the example of the Nano car developed by TATA motors which needed multiple inventions/innovations in technology and also needed cross functional teams working on different engineering disciplines to come together to solve complex issues and provide solutions while at the same time meeting the targeted price point.

“Reverse Innovation” is about the products designed for emerging economies being taken back to the developed economies and positioned there as ‘value for money’ products. This shifts the center of gravity where in the products once designed for advanced economies were stripped down and sold in developing economies whereas now the innovations made by MNCs in the emerging markets are taken back home to the advanced economies and positioned as ‘more for less’ products.

The Fortune 500 companies can now adopt a mix of ‘Innovation’ and ‘Reverse Innovation’ strategies to cater to the needs of a wider audience in their home countries as well as in the emerging economies. This will become a significant competitive advantage for these firms and help increase their top-line/bottom-line and thus the market capitalization. Let me try to illustrate the example of how this can work for say a mobile telephony operator which operates in both US and in India. In US the strategy of the CSP will be to harness the high speed data and broadband services to capture the markets from higher spending customers such as those using smart phones and tablets extensively for their day to day work. This will be possible due to the eco system of app providers, CSPs, high end customers and app developers. However if the same CSP has to operate in India where the voice till accounts for a majority of its revenues and where most of the customers still use ‘feature phones’ with basic features it has to carry out reverse innovation. To increase its data traffic in the absence of a large smart phone base it has to develop easy to use apps that can work on feature phones using just a basic browser or via simple apps that work on the top of the SMS technology. What is taken for granted in the advanced countries like the QoS and extent of network coverage are still largely absent in emerging markets. Some of the banks that have rolled out a Financial Inclusion programs on top of the mobile technology have had to work out options where in the customer can work offline and the sync up happens when he enters the areas where there is network coverage. Similar innovations can be exported to advanced countries for providing services to customers in the areas where the network coverage is weak or for customers who cannot afford smart phones.

The other key area that can be a part of the corporate strategy are the ‘bottom of the pyramid’ customers not necessarily those in developing nations but the ones who are relatively at the bottom of the pyramid in the advanced nations. This is the group of customers whose needs would be similar to those in emerging economies and thus would more than welcome the ‘value for money’ offered via ‘reverse innovation’ mechanisms.

When comparing the performance of the firms in the markets, we need to lay specific emphasis on the “net value creation” to the shareholders in dollar terms and not worry too much about the growth rate or the profitability % in isolation. The market value is based on the net present value of the anticipated future value creation to the shareholders over a longer time horizon which is function of both the growth rate and profitability. However in the recent past the emphasis has become way too much on the quarterly performance of the firm. This nature of the markets places a lower premium on the firms that invest money on Innovations and R&D and in many a case tends to punish the firm by under valuating it. The CEO of the firm needs to master the art and science of “communicating” the strategic intent and be able to exude confidence to the markets about the ROI and long term impact from the investments being made in areas related to innovation.

The strategy outlined above where in the combination of innovation and reverse innovation are used hand in hand is a win-win strategy for the global firm which has operations in advanced countries as well as in emerging markets and also has the double benefit of tapping the BOP potential in the advanced countries. Also the firms need to take a pause and convince share-holders to take a middle term view of the situation say like financial performance in 5 years from now rather than taking the short term or long term view of things.

Comparative Analysis of Infosys, TCS, Wipro and HCL -- Q4 and FY13 Updates

With Wipro results hot from the oven, we now have the quarterly results for 4 of the Top 5 Indian IT firms for the quarter ending March 31, 2013 (Q4, FY13). Now we have adequate data points and hence a time for reflection and comparative analysis of the performance of these 4 leading IT firms for this quarter. The numbers in the media are sometimes misleading as they mix up the INR numbers and USD numbers and portray the data the way they want to. Like always my comparative analysis is an ‘apples to apples’ comparison based on the IFRS USD numbers so that the Top firms are compared using the same yard stick.

The economic head winds do not seem to die down in the US economy and it is a painfully long wait to know what the real impact of ‘fiscal cliff’ and ‘sequestration’ will be on the long term economic performance of the world’s largest nation in terms of GDP. In the UK, the death of Thatcher brought in mixed emotions amongst the populace and this brings to the fore the tension between the “populist” politics and doing what makes perfect sense from an economics stand point. Thatcher did what was right for the UK’s economy from a text book perspective and had all the economic indices stacked up in her favor during her tenure at the helm but the opposition to her actions was very strong. Euro Zone leaders should take a cue from the ‘Iron Lady’ for fixing their economic maladies. China seems to be showing signs of slowing down and its lower GDP predictions have snowballed into lowering of the global GDP predictions for CY13 by the IMF. The commodity markets across the world have also shown sharp signs of decline with GOLD and OIL prices falling steeply.

This adds further to the volatility of the highly sensitive IT services industry which depends on the IT budgets of the large global corporations which are often being re-base lined on a quarterly basis in response to the global economic scenario. Forecasting growth for such a volatile industry with external dependencies is becoming all the more difficult.

TCS has shown a robust QoQ growth of 3.1% and YoY growth of 14.8% for the quarter ending March 31, 2013. This continues the trend set in the last quarter and is indeed a good growth rate over a large base. It has managed to maintain its Operating Profits as a % of revenues at 26-27%. In the long run, the growth rate of 3-3.5% would eventually become the benchmark for the top performing companies in the IT services industry. Looking at the annual results of TCS for the year FY13, the YoY growth of 13.7% over the FY12 numbers is pegged to the top end of the NASSCOM predictions of 11-14%. Consistency and a balance of growth versus profitability seem to be becoming the essential ingredients of the TCS performance over the last 4 quarters. TCS SG&A has increased over the quarters and has touched 21% in Q4 which indicates it is making substantial investments in making its sales force more formidable. TCS Volume growth was 14.8% for the year and is in sync with its revenue growth of 13.7% in FY13.

Wipro had given a guidance of 0.5-3% growth in revenues for Q4, FY13 and has met the lower end of its guidance with a growth of 0.5% QoQ in revenues for the quarter ending March 31, 2013. This is the lowest growth across the competitors and seems to raise a fundamental question on the revival of Wipro. Wipro’s growth across quarters seems to have had stabilized at the 2-2.5% range and was showing signs of green shoots all over but the current quarter’s performance seems to raise doubts and questions. The FY13 revenues have grown by 5% YoY over FY12 which point in the direction of recovery and we need to wait and watch Wipro for 2 more quarters to be able to arguably explain its revival. The operating margins also remain more or less constant around 20-21% over the last several quarters. The volume growth of Wipro in FY13 was 4.1% compared to its revenue growth of 5% which indicates that revenues are in line with the volumes and hence do not indicate too much of pricing pressures.

HCL has shown a QoQ growth of 3.1% in Q4, FY13 vis. a vis. 3.6% QoQ growth in Q3, FY13. HCL has been delivering a rather stable and consistent performance over the quarters on the growth front. It has also slightly increased its operating margins over the quarters and brought them to the 20% mark. HCL has shown a YoY growth of 12.5% for the year FY13 compared to the FY12 numbers. For the HCL scale of operations the growth rate is not as impressive as the market hype surrounding it makes it appear. However HCL has grown by ~30% in its Infrastructure Services vertical in FY13 which shows that its specialization policy is paying off. This gives precious annuity business to HCL which neutralize the bumps due to macro-economic volatility. The HCL volume growth was a mere 5-6% during FY13 whereas revenue growth was 12.5% indicating a non-linearity in its business.

Infosys QoQ growth rate of 1.4% for this quarter (Q4, FY13) is much lower than that of the previous quarter (Q3, FY13 which showed 6.3% growth QoQ). However I do not think this is much cause of concern as the previous quarter had very steep growth and it is not easy to sustain such high growth rates sequentially. Infosys could not keep up the promise made to the markets last quarter that it will do 6.5% growth in FY13. While it is true that Infosys did face challenges due to multiple reasons and could not meet the market expectations in Q4, FY12 (de-growth of 1.9% QoQ) and in Q1, FY13 (de-growth of 1.1%), the next  3 quarters viz: Q2 FY13, Q3 FY13 and Q4 FY13 did show a good sequential growth of 2.6%, 6.3% and 1.4% QoQ respectively. Infosys volume growth was 8.8% for FY13 and this did not reflect in revenue growth due to pricing pressures.

QUARTERLY RESULTS:

The summary of the Q4, FY13 performance analysis for Infosys, TCS, Wipro and HCL are as follows:

1. TCS and HCL lead in terms of QoQ Revenue growth at 3.1% with Infosys following at 1.4% and Wipro trailing at 0.5%

2. TCS leads in YoY Revenue growth at 14.8%, with HCL following at 13.6%, Infosys at 9.4% and Wipro trailing at 3.2%

3. HCL leads in terms of QoQ Operating Profits growth at 3.3%, with TCS following at 0.2%, Wipro at -2.4% and Infosys trailing at -6.9%

4. HCL leads in terms of YoY Operating Profits growth at 43.9% with TCS following at 9.8%, Wipro at 0.7% and Infosys trailing at -13.4%

5. TCS leads in terms of Operating Profits as a % of revenues at 26.5% with Infosys following at 23.6%, Wipro at 20.2% and HCL trailing at 19.9%

6. TCS leads in terms of SG&A expenses as a % of revenues 20.1%, with HCL following at 13.6% and Infosys trailing at 11.4%

Following is the chart showing the comparative analysis of these top firms on various financial parameters:

Q4, FY13 Financials
Parameter	Infosys	TCS	Wipro	HCL
Q4 Revenues(M USD)	1938	3040	1585.1	1190
QoQ Growth	1.4%	3.1%	0.5%	3.1%
YoY Growth	9.4%	14.8%	3.2%	13.6%
Q4 Operating Profits(M USD)	457	806	320	236.5
QoQ Growth	-6.9%	0.2%	-2.4%	3.3%
YoY Growth	-13.4%	9.8%	0.7%	43.9%
As % of Revenues	23.6%	26.5%	20.2%	19.9%
Q4 Net Profits(M USD)	444	663	NA*	192.7
QoQ Growth	2.3%	1.7%	NA*	8.6%
YoY Growth	-4.1%	12.9%	NA*	59.1%
As % of Revenues	22.9%	21.8%	NA*	16.2%
Q4 SG&A Expenses	220	612	NA*	162
As % of Revenues	11.4%	20.1%	NA*	13.6%

*Wipro does not give P&L for Global IT services separately. There is a single P&L for Wipro Limited

ANNUAL RESULTS:

The summary of the FY13 performance analysis for Infosys, TCS, Wipro and HCL is as follows:

1. TCS leads in terms of YoY Revenue growth at 13.7% with HCL following at 12.5%, Infosys at 5.8% and Wipro trailing at 5%

2. HCL leads in terms of YoY Operating Profits growth at 44.2%, with TCS following at 11.3%, Wipro at 5% and Infosys trailing at -5.2%

3. TCS leads in terms of Operating Profits as a % of revenues at 27% with Infosys following at 25.8%, Wipro at 20.7% and HCL trailing at 19.6%

4. TCS leads in terms of volume growth at 14.8%, Infosys at 8.8%, HCL at 5.5% and Wipro trailing at 4.1%

Following is the chart showing the comparative analysis of these top firms on various financial parameters for the financial year ending 31’st March 2013:

FY 13 Financials
Parameter	Infosys	TCS	Wipro	HCL
FY13 Revenues(M USD)	7398	11568	6217.8	4538
YoY Growth	5.8%	13.7%	5.0%	12.5%
FY13 Operating Profits(M USD)	1909	3124	1287	891
YoY Growth	-5.2%	11.3%	5.0%	44.2%
As % of Revenues	25.8%	27.0%	20.7%	19.6%
FY13 Net Profits(M USD)	1725	2561	NA*	688
YoY Growth	0.5%	15.7%	NA*	51.5%
As % of Revenues	23.3%	22.1%	NA*	15.2%

*Wipro does not give P&L for Global IT services separately. There is a single P&L for Wipro Limited

I will be back with more updates and ‘Value Creation Quadrant’ based competitive analysis once Cognizant announces its results in the first week of May.

Please do feel free to post your valuable feedback/comments on my analysis…

Note: The views expressed in the article above are purely the personal views of the author and have nothing to do with the firm he works for