Third-party service providers are redefining how they compete in the new digital world. The pressure to gain market-leading positions intensifies as the new digital business model threatens to shift market share and upend existing market leaders. At the heart of this new business model is a shift away from labor arbitrage and its FTE pricing to a software-defined model and consumption-based pricing. It’s a new world, and I believe it’s important for companies seeking to buy services to be aware of how service firms are investing to position themselves for the digital market.

Here are important questions in selecting providers for digital services: Is this firm just washing its products in digital technologies but has yet to reinvent its business model? Are you partnering with the provider to help you solve problems and use the best technology to solve those problems? Or are you partnering with the provider because it has the best technology for your problem? Although the two choices may seem very similar, they are quite different. Let’s look at the impact of the providers’ decisions based on investing in digital capabilities and how they are managing talent issues.

Three Distinct Paths Service Providers Are Using to Invest In Digital

For service providers, the three paths of investing in digital capabilities split on an age-old business decision: make vs. buy.

  1. Some providers are building digital technology platforms to compete in the new market. Prominent examples are IBM (through its investments in Watson and cognitive capabilities), Infosys and TCS.
  1. Other service providers are investing in digital by buying companies that have already built and mastered the new business models. Prominent examples are Genpact, Infosys and Wipro. They believe the greatest profit will arise from owning intellectual property, so they seek to own the technology or a part of the underlying technology. Providers following this path want to move quickly into the market and feel they don’t have time to experiment with the new digital business models.Examples of firms following the “buy” path are Capgemini, HCL Technologies and Wipro. Over the past year, they consistently bought small firms with niche digital technologies and paid a higher premium for capabilities so that they can scale their digital services faster.

    IP ownership typically starts off as relatively small revenue flow; thus, it scales more slowly in terms of absolute revenue, and it scales in relatively small increments. In effect, IP ownership is a long game. If there are rewards, it will be some years down the road.

  1. A third strategy for winning in the digital market is buying consulting or systems integrator (SI) companies – acquiring talent with expertise in consulting or implementing digital technologies. Accenture is perhaps the best example. These service providers want to stay true to their talent-based heritage and understanding of how to build their brand. This strategy is a much shorter time to capability than IP ownership and is more consistent with the providers’ existing business model; so, it carries less business risk.

Two Strategies For Gaining Digital Talent

A primary aspect of adopting digital business practices is that it requires new skills. It also places more emphasis on onshore resources rather than offshore. Using offshore talent is becoming far more difficult for service providers, and they face rising costs due to immigration laws and policies. Many are looking to hire in the US and EU, and all face huge attrition due to the shift from the labor arbitrage factory model to digital.

I note some significant trends in talent acquisition. For example, Infosys launched a $10 million employee incentive fund to help deal with attrition. Inconveniently, like the other Indian service providers, most of Infosys’ talent lack digital skills. The firm is attempting to retrain them, but this contributes to the attrition. Furthermore, Infosys at first cut employee bonuses in efforts to maintain its industry-leading margins as the industry shifted to digital models. But those margins are unsustainable in a digital world. Infosys is now battling to attract digital talent. The incentive bonus is likely to help employee morale as the firm changes its talent model.

US and EU immigration policies are forcing the Indian service providers to hire talent in those countries to accommodate onshore needs. The cost for landed labor is increasing and will cost the firms three points of margin. So far, the only Indian firm that has already paid this price is Wipro.

In addition, to get the volume of people they need in a competitive market, the Indian firms are putting training programs in place in clients’ locations. Although the US employees have more industry and cultural knowledge, they need a substantial boost to be productive.

Will They Be Successful Enough, Soon Enough?

Most of the major service providers have made progress in their digital journey over the past year. Who is ahead in this hot competitive race? What will we see for the remainder of this year? Here are my observations about the major firms.

Q4 brought a modest uptick in the market, which was largely a result of improving economic conditions and not a turnaround in the competitiveness of the Indian firms in the digital market.