HCL in search of its next big idea

In 2005, when the Indian IT sector was focused on application development and maintenance, HCL Technologies decided to combine its traditional strength in infrastructure services with application development and maintenance and offer what in industry parlance is known as total IT outsourcing. In total IT outsourcing, you manage the customer's applications and infrastructure (server, storage, network) together in a seamless way, and you offer a single rate for this entire work. 
Total IT outsourcing deals -- which are also a big focus of many big global IT services firms -- tend to be of longer duration, and margins in them are lower because the work is more generic in comparison to building customized applications for customers. 

HCL's emphasis on this space proved to be a huge success in revenue terms, even though it meant lower margins (its EBIT margins, barring in the latest quarter, have been less than 16%, as against over 25% for Infosys and TCS). Customers saw value in handing over the headache of their entire IT to a single vendor, and HCL was cheaper than the global players. During and post the 2008-09 recession, the value became even more apparent. Every time a big deal that was handled by a global IT vendor came up for renewal, HCL would benefit on account of its lower rates. 

Throughout this period, HCL had revenue growth rates higher than the average of India's top 3 IT firms (TCS, Infosys, Wipro), and the difference was particularly stark during the recession. The infrastructure services business scaled so rapidly - growing from $70 million in 2005 to $1 billion in 2012 -- that it now accounts for a quarter of HCL's $4 billion revenues. 

Research firm TPI estimates that $47 billion worth of total IT outsourcing contracts across 249 customers would be under renewal during 2012, of which some $15 billion would move to a different vendor. That's an over 30% churn, compared to the normal 20% that the industry sees (80% of contracts stay with incumbents). 

But this big vendor churn that HCL has benefited from is expected to slow down as global players begin to readjust their own prices. HCL's own estimate is that its current momentum driven by churn deals will be over in 18 months. Its CEO Vineet Nayar believes that post 2015, only about 5% of the contracts signed post-recession would change hands. 

So HCL now needs its next big idea. And that is what Nayar will focus on. There was speculation recently that Nayar was planning to disengage himself from the company, may be even quit HCL. But those look unfounded. The company says the recent decision to appoint Anant Gupta -- the man who led the spectacular growth of the infrastructure business -- as COO was to provide Nayar the time to find the next big idea or ideas. 

Gupta will handle the day to day operations of the company, while Nayar will spend a great deal of time in Silicon Valley, the heart of the world's technology innovation, and among customers. HCL has already set up a special division that will be responsible for brainstorming, innovation, idea creation, idea streamlining and incubation. Some 150 people, handpicked from the company's global talent pool of 85,000, are part of this exercise that will be driven out of Silicon Valley. 

"We want to cash in on the entrepreneurial energy within our company. The objective is to create a pool of innovative ideas that make sense to our customers and therefore keep us relevant to them in the future,'' Nayar says. 

But its lower margins has meant that it has much less cash to invest in new ventures compared to peers. As on June 30, it had Rs 667 crore in cash and cash equivalents, compared to Infosys's Rs 20,591 crore. To that extent, Nayar's ability to do new things would be limited.