Mr. Narayan
Murthy once described the business model of the Indian IT industry as an Udupi
hotel model. The reference originates from the Udupi hotel which have a frugal
business model based on cost volume equations. The hotels tracing their roots
to coastal Karnataka town of Udupi, are usually frugal, offer no frills,
usually standing only and drive their business model through a combination of
low prices compensated with high volumes.
In economics,
the quantity demanded is a function of the price elasticity of demand. As the
price increases, the law of demand posits a decline in quantity demanded and
vice versa. Yet, what is of interest would be the degree of change in quantity
demanded following a change in price. To goods with characteristics of being
price elastic, the decline in prices leads to more than a proportionate change
in quantity demanded thus the lower prices compensated by higher volumes. For goods
which are pretty inelastic, the change in price results in less than
proportionate response in quantity demanded. To Udupi hotels, the good was characterised
to be relatively elastic thus a drop in price caused a jump in volume
compensating drop in per unit contribution.
The Indian IT
industry too functioned on a similar paradigm. By the late 1990s, computing had
taken deep roots and was growing at a rate unanticipated by the ardent
proponents of IT industry. There was news than began flowing in that once that
date changes to January 1, 2000, the computers would not be able to recognise
the same and thus would become dysfunctional. The bug that crept inadvertently
during the manufacture of the earliest computers meant that had to be changed. The
Indian IT industry took this opportunity to offer to debug the same at very low
rates. This essentially was a price elastic market made for volume players. Therefore
it was not surprising to find the Indian companies getting a lion’s pie in the
contracts from the Western firms as they sought to race with time to combat these
bugs. Infosys, Wipro and many other firms big and small sought to latch on this
opportunity.
Around the same
time, the dotcom boom had grown into a bubble and unsurprisingly burst in the
late 1990s and early 2000s. The anticipation of the dotcom boom and the
expected transition of user behaviour from brick and mortar shopping to online
shopping meant network infrastructure grew at an exponential pace. Optical
fibre lines were laid across continents for the expected boom that never
materialised at least then. The data network infrastructure now lay idle and
thus prices went down. This meant an opportunity for many Western firms to
outsource their support or ancillary activities overseas. The data could be
transmitted through these networks at low prices or near zero prices, the bandwidth
was robust enough to handle large volume of data being transferred and there
was abundant cheap labour countries in Asia to perform these tasks. They might
transfer the data in the evening as they slept while the workers in India in
different time zone would finish the processing work by the times Americans
woke up.
Most of the work
was of low value add thus all characteristics for price competition. Non price
differentiation was difficult given the relative low skilled nature of the job.
Thus companies began to bid on price. The lower the prices, the higher the
volumes they were able to capture and thus compensate for the per unit loss in
contribution. As long as the good was price elastic the higher volumes
compensated for the price games being played around.
Yet as one
understands the elasticity of demand, the elasticity is never static. It is
dynamic and keeps on changing. At the certain points, the good instead of being
price elastic moves into a zone of price inelastic thus unable to compensate for
the lost per unit contribution. Indian IT industry to a great extent was caught
in a price trap. Moreover as other countries opened up with the ability of
engaging in the same work at lower prices the client firms too would shift
their business elsewhere. The Indian IT industry had to move up the ladder if
it has to have any chance of sustaining the industry life cycle.
It is thus, the
Indian IT industry functioned on a volume basis thus the colloquial name of the
Udupi hotel model. Some Indian companies have moved beyond the price
differentiation model to non-price differentiators thus moving the value chain.
However at every layer of the pyramid the market seeks to eliminate the non-price
differentiators to bring the competition back to the price differentiation. Irrespective of the nature of the industry, client pressures constantly
drive prices southwards. Simultaneously, client expectations of quality constantly
revise northwards. IT industry is no exception. It was an opportunity that was
encashed to the full some twenty years back. It is a constant endeavor of any
industry including IT to innovate and seek new avenues of differentiation.
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