Spinning off IT dept makes biz sense, but carries risk

Non-IT companies need to be careful when converting IT departments from cost centers into profit centers as such spinoffs carry significant risks, say market analysts.
Written by Swati Prasad, Contributor

Some non-IT companies, both in India and abroad, have taken to spinning off their internal IT divisions as a separate business entity in a bid to convert these cost centers into profit centers. However, industry watchers say such efforts carry risks as these companies can overestimate market opportunities and underestimate the competition.

In 1995, Emirates Group--which operates Emirates Airlines--spun off its IT department to form a separate tech company, Mercator, to meet the IT needs of all companies under the group. Others that had done likewise and spun off their technology arms as IT-ITES (IT and IT-enabled services) companies include GE, Bosch and Siemens.

In India, too, several IT companies have been borne out of non-IT companies. These include:

•  TCS, which is part of the Tata Group--a conglomerate with businesses in chemicals, materials and engineering;

•  Wipro, which a few decades back was known more for making hydrogenated vegetable oil;

•  ITC Infotech, which parent company ITC operates FMCGs (fast-moving consumer goods), hotels, paperboards and packaging, and agribusiness;

•  L&T Infotech, which parent company Larsen & Toubro is a technology, engineering, construction and manufacturing market player;

•  Religare Technologies, which is part of the Religare Group that has business in financial services, healthcare, wellness, diagnostics, aviation and travel;

•  Ramco Systems, which parent company Ramco Group manufactures cement, fiber cement sheets, production of cottons and synthetic yarn, among others; and

•  Highbar, which parent company HCC Group offers engineering and construction services.

"Many non-IT companies globally had historically invested in IT and technology, and built terrific software products to solve some of the pressing problems in their core businesses," Sundararaman Viswanathan, manager of consulting at Zinnov Management Consulting, said in an e-mail.

He added that these software products were later sold to other players in the industry and, thus, some companies became IT software product vendors while others created services companies to provide implementation services of those products--even specializing in other products.

Take the case of Amadeus, for instance, which is the de facto software used by the travel industry for reservations, Viswanathan noted. It was borne out of an alliance between Air France, Lufthansa and SAS, and later spun off as a technology and IT services provider, he said.

Similarly, its competitor Sabre was originally a software product operated by American Airlines, and later spun off into a separate IT company.

"Since the technology business, especially software products, is largely non-linear and IT services are a high margin business, it makes sense to capitalize on it," Viswanathan said.

Means to retain talent, reduce operating costs
The IT infrastructure of medium to large non-IT companies encompasses various technologies that require vast technical skillsets to monitor and manage the system. "Technical resources have to be made available 24-7 for business continuity," Srinivas Anappindi, CIO of CSS said.

However, he noted, these resources may not be occupied for the entire duration of their shift, leading to inefficient utilization of highly skilled resources. Offering year-on-year pay hikes is a challenge for the company, thereby, making retention of IT personnel a difficult task.

"Rendering IT services to external clients and making the IT department a profit center addresses this challenge," Anappindi said.

Apart from facilitating IT staff retention, tech spinoffs also offer companies the benefit of managing internal IT infrastructure at lesser costs.

"Getting talent becomes easier," Ambarish Dasgupta, consulting leader at PwC India, said in a phone interview. If companies are unable to attract quality skillsets for their internal consumption, spinning off the IT unit then makes sense, he said.

Dasgupta added it will draw more talent and also create another channel for profit. For the IT personnel, it means lesser monotony and they get to learn more and grow in their profession.

Viswanathan said: "Spinoffs give companies the opportunity to create non-linear revenues." In addition, if their IT department caters to other customers, earns revenues and becomes self-sustaining, it provides an opportunity for the parent to subsidize its own IT spend, which is typically 2 percent of overall revenues.

"For example, in a US$10 billion company, the IT spend would be around US$200 million. If the IT operations of this company are self-sustaining, the company can plough back that US$200 million into its core business," he explained.

Conflict of interests
While it offers several business benefits, chances of an internal IT division becoming a successful spinoff are, in fact, low.

Dasgupta said: "Big groups are attempting such spinoffs but they are not confident of it." He noted that these spinoffs require absolute focus and companies need to stay committed to the cause.

He added that risks involved are higher and in most cases, such companies end up overestimating the market opportunities, while thoughtlessly underestimating their competition.

Also, he said there cannot be a conflict of interest between the needs of the group and its client.

According to Anappindi, the key challenge is to secure business from its first customer without an external case study to show as reference.

"Companies need to plan, identify the technology solutions that were implemented well within the organization, and offer these solutions to external clients as a boutique of services to start with," he said.

Viswanathan said companies planning to spin off their IT departments as profit centers need to be careful for more reasons than one. First, it is not their core business, especially for companies operating in traditional verticals such as BFSI (banking, financial services and insurance), retail and manufacturing.

"It requires enormous amount of investment--both in terms of money and corporate bandwidth--to build an IT product or services DNA into their IT teams," he said.

Also, competition from current players or veterans in the market will prove a challenge.

Viswanathan explained: "In some cases, customers which the IT department--or spinoff--might be catering to could be a direct competitor in the parent's core business. Therefore, the businesses run the risk of sharing such a technology capability."

Dasgupta added that spinoffs are more likely to succeed in cases where the parent company is in the manufacturing industry. The success rate also is higher if the IT department is spun off as a BPO (business process outsourcing) or a KPO (knowledge process outsourcing), rather than a pure IT or IT consulting company.

Swati Prasad is a freelance IT writer based in India.

Editorial standards