When I started Neev 6 years ago with a friend, many people thought its foolhardy to start a software services company in today’s age. The golden period is behind us and the biggies are already entrenched. Today again I hear the same arguments. Even NASSCOM which is trying to engage more with smaller companies is encouraging more companies to do products rather than services. In the meanwhile I have seen multiple companies start and create services businesses doing several million dollars in revenue in this last 6-7 years.
Product companies generally create more value and there seems to be more glory in the cause of starting a product company. I myself am a strong believer in products and IP. However, does one exclude the other? Isn’t there still space for more services companies. Why should the National Association of Software Services Companies give up the cause of the small service company? And why can’t we have thousands of product companies AND thousands of services companies. We are not short of people, are we?
As I understand, currently there are 5000 software companies in India with less than $5M revenue. The latest revenue figures of the IT sector say that ~$50 billion is the 2011 number (excluding hardware and BPO which take it up to ~$75b). The exact numbers are probably not required for this thesis but its good to have the ballparks in mind. My guesstimate is that the bottom 5000 companies probably have an average revenue of $1M, making them together earn $5b of revenues or less than TCS alone. The comparison with TCS is intentional. Since the Tier 1 companies such as Infy and TCS have the maximum mindshare we tend to benchmark all IT companies with them. Some say, wouldn’t we be better off with one more TCS with its economies of scale rather than 5000 struggling companies. This symptom is also called the Tyranny of the Or since again one option doesn’t preclude the other. Take a look at how revenues are shared in the IT Services ecosystem:
Revenue Distribution (guesstimates by author 
)
The larger companies also have a good portion of BPO revenue which is not a part of the above numbers. The interesting question to ask at this stage is, where does the money come from?
Client Revenue Mix
It seems pretty obvious (sometimes in hindsight) that size begets size and the companies outsourcing to the bottom 5000 are not the same one’s to the top 20. It should also not come as a surprise that we can explode the bottom 5000 companies also into a self-similar structure with really small companies doing revenues of $100-200k catering to 10s of thousands of small customers all over the world. The average project size here ranges from $2k to $200k, in itself a large range. This is really the SME sector of IT industry and it begs to be studied in more detail. We don’t understand them well enough as a group and nor the many variations in this category.
So now it should look obvious that this is a separate market which a TCS like player doesn’t cater to (and can’t). To not focus on the bottom of the pyramid on both the sides would mean leaving (lot of) money on the table. Now the real potential: the tier 1 clients won’t increase from 1000 to 10,000 but the 50,000 clients being catered to right now in the bottom segment are just tip of the iceberg. These are perhaps the early adopters of outsourcing in their size of companies. Once they are successful, the next wave of 500,000 clients will jump on the outsourcing bandwagon. Even today I see many clients in this segment shocked when they see that serious purpose built software can be developed at times in budgets of $10k or less (mainly due to open source maturity in last 10 years and also due to general software development maturity). So lot of this outsourcing is not projects diverted away from local players but projects which would have never happened since the budgets were always short of the requirements. Large players by definition can’t cater to these clients and we will need the next 50,000 software services companies in India to capture this market. These will be companies with an average of $1M revenue making a total of $50b (as much as the current total size).
In all economies it is this mass of SMEs which make for a healthy sector and there is no reason why Indian IT sector should be exempt. These are the small nimble players who will latch on to new trends, take new bets, will be happy to work in very small niches. Can’t imagine Infosys doing Magento eCommerce projects, SugarCRM implementation, Drupal sites or making $5k iPhone apps. This will also be a segment of great churn with large number of players exiting and entering the arena every year. The segment as a whole will show great resilience though and will really make India into an IT services powerhouse which can’t be dislodged. A key role in this ecosystem will also be played by platforms matching buyers and sellers of services since a major challenge will be for these small players on both sides to find each other.
This is not pie in the future but probably the lay of the land in the next 10 years. Is it for you? Well, if running a Rs 10 Cr ($2.5M) business that requires no seed capital to start doesn’t seem beneath your ambition hop on the bandwagon!
Nice article Saurabh! I certainly hope your hypothesis about the ‘next wave’ of clients is true in IT services and in other services (analytics, research, etc). As in IT services, in the analytics & research business too, large players are focused on large retainer deals and don’t have the bandwidth to pursue smaller projects (with much higher margin).
Thanks! I agree, the same thesis should apply for other outsourcing segments. Its just that I used software since thats what I understand better.
It is really analytical post about IT industry and Others. Thanks for this informative post.