I have been working in the OPD space (Outsourced Product Development) for a little over an year now. Having worked in product companies for the last 8 years, I joined this space to get the experience of driving multiple products development lifecycles within a relatively short time, and to that extent this has been a wonderful experience. We have launched 4 new products starting from early concept stage and all are now in production.
Coming back to the OPD industry. I had all along assumed that since the OPD industry operates relatively higher up the value chain – as compared to the generic IT maintenance projects – this industry would command relatively premium pricing and higher margins.
Product development typically requires a more considered and generalized approach to problem solving and product organizations are relatively more particular about their hiring. Average compensation structure in product companies is also typically higher than those offered by IT services companies. On the other hand, most product organizations have a smaller team sizes and are more sensitive to attrition.
So, I was a little surprised when I searched the web for financial results of the players in the OPD segment (e.g., GlobalLogic, Persistent, Aztec, R-Systems, etc.) vs. Generic IT Services (e.g., Infosys, Wipro, TCS, etc.).
Net profit margin for select OPD players:
8 % (R-Systems), 16% (Aztec), 17% (Persistent)
Net profit margin (Generic IT Services, for 2009 ):
18.6 % (TCS), 19.5% (Wipro), 28% (Infosys)
The verdict: Generic IT Services companies beat the OPD companies comfortably, despite significanty higher business volume (at least an order of magnitude more than OPD companies). If you factor in the conventional wisdom – as size grows, you start hiting the lower end of the market, adversely affecting profit margins - then the effective difference in profit margin is probably even higher!
How do you explain this difference? I can think of the following reasons:
1) Current OPD players are not really operating as high up the value chain as is perceived – This suggests that a large part of the product development is basically around implementation of product specifications, which may be fundamentally not very different from other IT services. I don’t know if that is indeed the case, and would probably require project-specific data to identify which category of projects are more profitable than others.
2) Lack of economies of scale – All OPD players are relatively much smaller in size - about USD 100 million or so. Does size play an important role in increasing profit margins? Does it help spread the costs of key resources over different projects. That could be a reason. Not having an expensive resource fully billable could directly affect the top-line. Having scale probably allows companies to ensure higher utilization of key resources.
3) Inefficient business practices – This relates to things like (a) managing internal costs (b) resource allocation practices (c) alignment of sales with delivery etc. These can also quickly add up to the costs without driving up business.
Looking at the difference in profit margins within the Generic IT Services industry, Infosys for example, has by far the highest profit margins are compared to TCS and Wipro. To me, this is an example of how companies in the same business – that too in reasonably mature industry domains – can still differentiate themselves. So, could it be simply be point (c)?
Also, it follows that if the reasons for lower profitability is either of points (b) or (c), then OPD companies could soon be an acquisition target for the other Generic IT Services companies. These companies can potentially squeeze out more from the same OPD business, by applying their best practices from the Generic IT Service domain?
