Economic Vulnerabilities and Its Costs

Economic Vulnerabilities and its costs:-

Organization has been growing at a rate of 30% over the last 5 years and much of this growth has been fueled by strong demand for outsourcing services as well as Organization's investment into its infrastructure and human resources.

The major component for the cost of revenue for its applications outsourcing services is salary for skilled software professionals, followed by the hardware environments to support software development, maintenance, and software licenses. The software cost includes proprietary software, tools and packaged software. Additionally, the skilled software professionals require investment for both Organization-specific and client technology-specific knowledge training.

As these employees become highly skilled at the specific technology it becomes costly to replace them and the cost becomes a "quasi fixed' cost. This is due to the fact that the portfolio of legacy systems software is usually the dominant portion of its installed base of software, and requires specific knowledge of its usage and implementation.

Furthermore the labor market regulation imposes severance costs for cutting the labor force and as Organization has already invested in the enhancement of skill, knowledge and overall quality it becomes difficult to layoff skilled workers and loses the opportunity to amortize their investment. Hence when the economic environment sours which is outside Organization' control it reinforces the 'Quasi Fixity' due to its investment in resources which results in type-1 vulnerability for Organization. As a result of these external events, it cannot layoff the experienced workers and lose the opportunity to amortize their investment whereby adding costs to its operations and squeezing its bottom line. There was ample evidence of this during 2003 and again seen in 2010.

Secondly, lot of the software purchased is specific to the client's requirements and cannot be easily repurposed due to the depreciation of software assets and can be considered sunk costs.

As a result of this the SRATC curve for Organization represents a moderately steep "U" curve. This represents a Type 1 Vulnerability wherein the intensification of the competitive pressure leads to decreasing market share and prize pressures which can squeeze the operating margins and makes it vulnerable to external shocks.

Approximately 79% of the billable workforce is based out in India and due to the growing shortage of highly skilled professionals with lot of competition, the wage costs have been rising significantly. As Organization's success depends on its ability to attract, retain and effectively utilize highly-skilled professionals, the shortage has caused salaries to rise which has raised the Short run average cost rise. As a result of this there has been an increased margin pressure.

The conclusion of this is that Organization has significant exposure to Type1 and Type 2 vulnerabilities to the nature of its cost structure as shown in table below.

%

%

Internal Costs as % of Total costs 0.18

Fixed Costs as % of Internal Costs 0.78( High Type 1)

External(hiring) costs as % of total costs 0.35( Med Type 2)

Organization's Market Exposure

Organization's Competitors:-

Organization's gets 92% of its revenues from the Fortune 500 companies where they work with the I.T organization across the Enterprise to provide outsourcing services. As a result of this, they come across strong competition from large as well as Mid-sized Outsourcing providers.

Organization is ranked at 16th among the Indian Outsourcing providers by NASSCOM in terms of revenue but has outperformed some of its peers with operating margins of 28% which is one of the highest for Outsourcing providers where the average Operating margin is around 15%.

Even though there are many IT service providers who cater to the Fortune 500 companies, Organization has been able to differentiate itself through high value application management services using its Global Delivery Model and customized frameworks and processes to meet the clients needs.

This has been a source of Organization's market power due to its differentiated product which means that it faces a downward sloping demand curve and is moderately inelastic. The cross price elasticity of demand between the services offered by its competitors is positive, but Organization's services are described as close but imperfect substitutes. The services offered by them perform the same basic functions but have subtle differences in how, where and what is offered to distinguish them from each other.

As can be seen from the above figures, the overall industry profitability is around 14% which is a supernormal profits (greater than 8%) and Organization is one of the leaders in its peer group in both the overall operating margin as well as the net profit per employee figures.

This demonstrates that even though the Supernormal profits have attracted new entrants into its market who try to reduce the cost to their service, Organization has managed to maintain its margins through its Application Outsourcing services which require a very good understanding of the client applications. The extensive knowledge transition and high switching costs required to onboard a new provider for the client reduces the threat of new entrants into its key markets and ensure it does not descend into Strategic Hell.

Price Elasticity :-

Organization believes in a "Customer for Life" philosophy which emphasizes flexibility, responsiveness, cost-consciousness and a tradition of excellence. It is focused on the organic growth within its existing clients which account for almost 80% of its overall revenues wherein it is able to expand the range of services due to its understanding of customer's applications and business.

Figure: - Organization's Price Elasticity

Most of the services provided by Organization require deep understanding of the client's business application