Kudos Infy - You have the right Strategy, but Innovation is the Key

"High Growth comes from balance, you will see us moving towards growth and profitability with the balanced approach that we have adopted"  these were the words of Mr.SD Shibulal after the Q4-2012 quarterly results were announced on 13th the Friday.  These words summarizes what Infosys "stands for" and "will stand for" the years to come.  Right from the days of NRN, Infy never chased volumes at the cost of profits, they were ready to sacrifice volumes if there were no profits.  This strategy has worked for them for the past 30 years and will work for them for years to come.  True after announcement of results analysts battered Infy, stock prices of Infy crashed by a double digit percentage, but the legend lives strong on its principle of growth with profitability.  

Infy has a clear strategy of superior financial growth and strong margins and they have stayed with it.  Let us look at numbers of Infy and other major IT players to understand the strategy of Infy vis-a-vis others.  As now is the trend to look at quarterly numbers let us also look at the "Q" numbers.

                                  NYA - Not yet announced
The analysts are right definitely Infy's revenue growth is under test compared to its peers, growing slowly over the quarters @ 4.6% lowest among its competing colleagues.  Does this mean that the magic of Infosys has waned away?  We have only seen one parameter of the strategy which is growth, let us look at the other parameter Margin.

Here Infy & TCS win hands down, margin @ around 40's where as others are in 20's.  Clearly Infy is living up with its strategy of growth and profitability.  Is it a good strategy to have?  Definitely yes because of the following reasons :

1. Avoiding Cost Sensitive Clients - This strategy means not working with highly cost conscious clients, whose primary aim is cost and second comes the product.  If there is a price upward revision these clients simply dump the existing vendor and move to another who offers lower cost - No Loyalty 
2. No Cross Subsidization - Infy looks for profit in every business / client.  This is a very good option, some companies will look at taking clients at very low margin because of volume with the belief that from some other clients they will get higher margins. This is cross subsidy.  Margins will be under severe threat when the higher margin clients exert price pressure 
3. Falling Quality Standards -  In the long run with margins dropping there will be pressure from investors to keep profitability at reasonable levels.  At that point reaching to customers with price revisions may not be possible, which means cutting costs and some times at the cost of quality 
4. Increase in working Capital -  Companies with lower margins tend to have higher working capital requirements, as over a period of time their margins will be inadequate to cover Receivables & expenses.  This is turn would mean requirement for working capital and its related costs
5. Spreading Too Thin -  With volumes increasing constantly at the cost of margin, companies will like to make optimal (high) usage of resources meaning expectations of higher productivity from the existing assets (including Human Resources).  This will over a period of time lead to "Over Utilisation" of capacity and consequent costs related to it will occur
6. Price Pressure from Clients -  During difficult times like Euro Crises, clients will definitely like to cut their spends in whatever form and the first cut will happen in services, which means IT.  At that point if the margin is reasonably high then a small cut in margin will not affect the company's cashflow and once things are back to normal the margins can be restored.  But on the contrary if margins are low then taking a cut in margin will be very difficult as it would mean (at times) borrowing of funds to meet working capital expenses which will also add to profitability woes.
7. High Investment -  High volume of business means requirement for higher investments in infrastructure.  Cost of maintaining this infrastructure should also be added to this.  When margins are thin this will be definitely a strain on business funds over a long period of time
8. More Work less money - Though Revenue  per employee / asset will be higher in companies with lower margin high growth, Profitability per employee / asset will be lower, meaning "More Work, Less Money".  Again in long run this will have its own impact

In the long run definitely the strategy of Infy will be very solid - Growth with Profitability.  But the million Dollar question is how do they achieve both?  This is where I admire companies like Microsoft & Apple.  Both of them rely on innovation.  I like the words of Bill Gates who once said "For me a product is obsolete once it is launched", which means as soon as he launches a new version he considers it to be obsolete and goes back to the drawing board to innovate and launch new products.  Apple with its "i" range of innovative products has taken the market by storm and it not only grows leaps and bounds but also its profitability is sky rocketing.  For information Apple's Gross Margin is in the 40s and Microsoft's Gross Margin is in the whopping 60s.

In short, if Infy has to maintain its strategy as well be a darling to its stake holders it should Innovate.  It should roll out more and more innovative products and price them at a premium and earn higher margins.  One aspect always surprises me is that Infy (and most of the Indian IT companies) are excellent in rolling out SAP by being partners of SAP, but no one has ever tried to create a product like SAP and successfully roll it out (though some have smaller versions of it)?  This is where Indian IT companies have to innovate.  

My advice - Infy turn to the drawing board invest in R&D, roll out innovative products and then surely you can walk your talk of Growth with Profitability, if not you will only provide lip service to your strategy and see your competitive colleagues zip past you.