Without apologizing ad-nauseam, let me get straight to the point. ISB has a very active Business Technology Club. As part of the club proceedings we invite leaders and practitioners from the Technology industry to share insights with students. Ananth Krishnan, the Chief Technology Officer of TCS addressed club members on Wednesday. It was a very insightful talk that traced the course of the software services industry and discussed some of the fundamental growth problems that the service industry faces today.
Key takeaways were:
The IT services model was pioneered by Ross Perot the founder of EDS. He chose to base it on a pricing model widely used by the professional services industry (dentists, lawyers, consultants). Soon the model would become the pricing norm in the IT services industry. The model worked on the principle of leverage one gained from having more experienced and renowned professionals as supervisors. While the bulk of the day to day activities would be performed by relatively inexperienced professionals, the experienced professionals would be the ones who would get business for the firm. In this manner the whole (firm) would earn more than the aggregate of what the parts(employees) could earn individually. This worked well till the smalls were small in size. As the firms began to grow larger, revenues per employee started plateauing. The aggregate revenues of the firm over time became proportional to headcount.
This problem is described in management literature as the Linearity Problem.
As organizations become larger and larger linear growth becomes more and more difficult to sustain. Ananth went on to explain how TCS is addressing the problem of non-linear growth by exploring business lines which could generate non-linear growth.
I have been thinking about the traditional way we price IT service contracts. I have seen most mid-level managers use a cost-plus approach to pricing. You calculate how much the resources you use cost the firm. You add a fixed percentage margin and arrive at your ask price. This makes an organization fall into the widely known cost-plus trap. When demand for services is lower the firm increases prices to generate the same amount of profits as it did earlier. This is counterintuitive. When demand is lower one cuts prices to generate more demand and not the other way round.
A better strategy is a pricing structure based on differentiation. At the start of each project measure the economic value you add to the clients business. Base your pricing decision on a percentage of that economic value. This is a better way of pricing services. But it calls for a large change in the mindsets of people who make pricing decisions in firms. Cost plus is simple to apply while differentiation is more difficult to measure.
We had Piyush Pandey, Chairman Ogilvy and Mather India, with us today. But, more on that later …..
