The golden age of technology services startups

The Indian technology services industry is a behemoth. In the last financial year, it recorded revenues of $245 billion, contributing 25% of India’s exports. Three of top five global players by value are Indian, with combined revenues of $58 billion and consistently generating 20-25% EBITDA margins.

However, despite numerous success stories, this industry has largely eluded venture capital. Startups in tech services typically bootstrap themselves with no VC participation. They rarely show up in the list of Unicorns, even though there are many private companies with over $1 billion valuation tag. Why is that? Is there no case for VC in the sector?

Having invested in the space for two decades, we think otherwise. In fact, we believe we are entering a golden phase for tech services startups, and venture capital can play a pivotal role in building the next generation of leaders. So let us bust a few myths that in our view come in the way of building a vibrant venture ecosystem in the industry.

Myth 1 – Tech services is a manpower business and tough to scale

Tech services companies build and maintain clients’ technology systems. They often know these systems better than their customers. This results in a very sticky relationship which scales elegantly as the client’s needs grow. As a case in point, world’s largest tech services company Accenture has annual revenues of over $64B, larger than any other software company but for Microsoft.

And these businesses can grow fast too, given the ability to hire and train manpower at scale. Just as a comparison, Freshworks took four years to grow from $100 million to $500 million in revenues, while Infosys did that in just three, while still compounding at 40%+ per annum at that scale. I have personally been part of an investment in a company that grew from less than $15M to over $150M in just four years!

Myth 2 – With software led automation, tech services industry could shrink over time

We believe advancements in software only aid the tech services industry instead of shrinking it. The advent of packaged software in the 90s created a large implementation and customization revenue base (often 5x of revenues captured by the software platform). Then came public cloud that required migration and re-development of legacy code base and implementation of cloud-based data platforms and SaaS. The current AI wave could make tech services even more central by driving another technology refresh and creating demand for custom AI models to suit the specific objectives of each enterprise.

Not surprisingly, global services industry (at $1.3 trillion) continues to be larger than the software sector, and has grown steadily over the last 20 years, despite deflationary impact of India led offshoring.

Myth 3 – The industry will consolidate around the global vendors, making it tough for startups to scale

The saying goes that no one gets fired for hiring IBM (which used to be the pre-eminent technology services business back in the days). A typical global enterprise has relationships with majors such as Accenture, TCS and Infosys, which have built large-scale talent sourcing, training and delivery engines. Then why should there be a need for new players in the ecosystem?

The answer lies in the constant innovation in the technology landscape. Every new technology creates the need for new skills with projects being smaller and more complex than what incumbents are focused on. Some of these could also be disruptive to traditional business models, potentially cannibalizing existing businesses. For example, advent of public cloud changed the entire application development and infrastructure management methodology. AI has the potential to boost productivity that could be tough for big tech to adopt as they get paid on a man-hour basis. All these provide an entry point to niche players, which start small, build trust with customers and subsequently broaden their remit to grow over time.

This is reflected in the pace at which startups have been scaling in the industry. As per our estimate, at least 24 tech services companies achieved valuation in excess of $1 billion over the last 10 years, compared to 14 in the SaaS space. Of these 13 are still private (but only 3 show up in the so-called list of “Unicorns”!).

Myth 4 – There is limited value that venture capital can add

Unlike SaaS, tech services companies can be profitable from the start. Most of the scaled players never raised a dollar of venture capital. So, in venture capital’s defence, why focus on something that is not looking for your money?

In our view, tech services firms are right in bootstrapping initially. However, once they reach critical mass (say $10M of revenues), there are multiple ways venture capital can be valuable in their scale up journey. Firstly, primary infusion of capital could provide the ammunition to deepen their niche capabilities by investing in R&D, and building solution accelerators. Companies could also expand sales & marketing as well as hire delivery manpower in advance to grow faster. Finally, an investor could be a strategic thought partner, bringing a global network of relationships and helping build operating and governance processes that can radically change the long-term trajectory of the business. We have already seen examples of companies such as Happiest Minds, Fractal and Quantiphi that have proven this playbook.

Given the growing pace of tech innovation, the Indian tech services startup ecosystem is primed for success, and they can benefit hugely from venture capital. At Filter Capital, we actively focus on the sector and have assembled a group of senior industry professionals who support us in this endeavour. So if you are building a unique services company and have the aspirations to scale and build a lasting business, we would love to have a conversation.