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IT consulting companies have enormous potential if they focus on profit margins, brand equity, and IP, say T Sen and P Ghandforoush

IT Consulting Companies: Financial

strategies for GrowthThe service outsourcing model has become a global phenomenon resulting in thousands of small and large consulting firms around the world providing a wide range of services in the IT, business process, legal, health, financial, marketing, and other vertical domains

consulting companies in the information technology (IT) area have mushroomed since the early ‘90s as corporations chose to outsource their IT

needs to them. As technology be-comes diverse and complex, it ceases to be cost-effective to hire or retrain employees, to keep up with the new technologies and applications. The ini-tial level of complexity in the IT world started with client-server technologies that led to increased interoperability requirements producing complex IT architectures that were prohibitively expensive for companies to support in-house. This resulted in the outsourcing of their IT needs to other consulting companies.

Although consulting companies have been around for some time, the primary growth spurt came from the Big 8 accounting firms of the ‘80s and ‘90s. Accounting firms for audit and tax services were already provid-ing services to corporations. Given their connections and knowledge of the domain, it was easy for them to leverage this access and expand to IT

consulting services and this became a win-win strategy for both corpora-tions as well as the accounting firms.

Corporations obtained ready partners to whom they could outsource their IT activities and the accounting firms were more than willing re-cipients of this windfall. This of course, led to the well-publicised conflict of interest issues that re-sulted in several consult-ing divisions spinning off their accounting areas of business.

The IT consulting model became so suc-

cessful that corporations like IBM, Booz Allen, SAIC, CSC and other global consulting and, or technol-ogy companies adopted this as their primary business model. In addition, the outstanding cost and talent advan-tages that India provided, led newer global consulting firms like Infosys, Wipro, TCS, and numerous others to the emerging markets worldwide and India, in particular.

The service outsourcing model has become a global phenomenon result-ing in thousands of small and large consulting firms around the world providing a wide range of services in the IT, business process, legal, health, financial, marketing, and other vertical domains. The US Federal Government is one of the largest consumers of consulting services. Unlike manufac-turing, the risks and barriers involved in the entry to the consulting world of business are relatively smaller. How-ever, it is far more complex and chal-lenging to start, sustain, and nurture a consulting business model compare with a traditional manufacturing model. This article focuses on some of these challenges faced during the various stages of growth of a consult-ing firm, and the growth model at each of these stages. The stages of growth are early stage, mid-stage, maturity, and IPO-buyout stages. The cycle of growth however, is quite traditional and unlike the product market, the expectation of exponential growth is infeasible. Consulting sales are made one-at-a-time, and go through long sales cycles. The growth of a con-sulting firm is directly related to the number of employees. The number of employees can grow only if there are more consulting sales, and there

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can be more consulting sales only if there are more employees selling and delivering.

Early StageMost consulting companies begin

with primary owners having some domain strength, using which they are already embedded in a corporation providing some services. The expertise can be either functional or technical, depending upon the experience of the promoters of the company. It is important that early-stage adopters of the model start with one client and a signed contract, unless they are able to attract venture capital funding. Without this approach, a sales and marketing team needs to be in place and this creates a significant barrier to entry. For a small business, a sales and marketing team is prohibitively expensive.

The entrepreneur is faced with two choices of financing: To finance the company through an early-stage contract, or build the company as a business around a niche area of ser-vice, and finance it through financiers like venture capitalists, owner’s fi-nance, angel investors, banks, or some other form of financing. Financing the company through an initial contract is a safe strategy and several busi-ness consulting firms often adopt this strategy. This is a risk-averse strategy and can lead to organic growth that is sturdy and profitable, but is unlikely to have inordinate growth in a span of

a few years. Scaling up rapidly needs external financing.

The self-funded model has other challenges including working capital management; severe cash flow prob-lems at the initial stages, and little or no capital for any growth-related investments. The financial attraction of this strategy is that the company can become profitable in a very short span of time, even though the top-line growth is nothing to write home about. This growth model uses a more aggressive approach at the mid-stage level.

Chart 1, shows that the growth rate goes down after an initial spike. This happens in all stages of growth. It is near impossible to maintain an

increasing growth rate over a sus-tained period of time. However, it is important that at the end of each stage, renewed effort is necessary to increase the growth rate again.

Mid-stageManaging cash flow and work-

ing capital is a common problem all consulting companies face. Manag-ing cash flow while continuing to generate working capital, is one of the most pressing concerns facing these companies. There is always a time lag between providing services and receiving cash payments for services rendered. The business has to take care of payroll as well as other busi-ness overheads, as and when they are due. The better the time gap between the accounts receivables and accounts payables is managed, the higher is the likelihood of success. A good way to counteract the working capital prob-lem is to bill the clients in a timely manner and follow up on collections methodically. Planning using cash flow statements is also very helpful at this stage. Payments can be planned and staggered based on receivables. However, one area where this is not possible is the payment of employee salaries, which usually cannot be staggered. Often small consulting firms resort to sub-contracting work to better able to manage cash and pay sub-contractors only after clients have paid. All client accounts should be reconciled at the end of the month and followed up as necessary. This results in minimal working capital requirements and positive cash flow for the business.

Growth at this stage can come from expanding into new markets, provid-ing more services to existing clients, enhancing productivity, and forming joint ventures and partnership allianc-es. If sales are diminishing or there has not been substantial growth at the on-set, then expanding into new or related service offerings, especially ones that complement the current ones, while striving for deeper penetration in the current market is a popular strategy. Global services companies like IBM have also used this strategy to expand business. Consulting firms may also

Chart 1. Business Growth Rates Through the Stages

Financing the company through an initial contract is a safe strategy and several business consulting firms often adopt this strategy. This is a risk-averse strategy and can lead to organic growth

Grow

th R

ate

Mid stageEarly stage Maturity

Time

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join forces with other companies to expand their existing client base, by partnering with other clients and in-tegrating their products and services to offer clients a more comprehensive and appealing package.

Having a sales and marketing pro-cess that generates continued business is essential for growth. Most consult-ing firms suffer from a feast or famine situation that threatens their existence and makes them susceptible to either premature takeovers or bankruptcy. A healthy business pipeline created by resourceful sales and marketing teams is a good investment for any consulting company. More often than not, consulting companies neglect developing a good marketing strategy and leave the sales to a few precious high achievers in the sales team, or rely on unexpected sales opportunities leaving themselves vulnerable to an unpredictable pipeline. Marketing cre-ates a value proposition for the firm. This can in time, command greater market attention providing an edge over key competitors and hopefully higher fees for consulting services.

Consulting is a people business and therefore, human resources are the most valuable asset. By managing knowledge, continuous vigilance in hiring practices and a hard commit-ment to retaining employees, a con-sulting firm can establish a good group of valuable consultants to attract more

business. Acquiring, maintaining, and managing intellectual property im-proves the firm’s market potential and gives it an upper hand when dealing with competitors.

A good management with ex-perienced leadership is a precious asset to any company. At this stage, the company needs a management team that spends more time working outside, networking and building contacts. Forming an organisational structure and framework conducive to the established goals of the company is another key area the management

needs to support. A good chief execu-tive is focused, innovative, and exhib-its adequate control over all business operations and finances.

The revenue growth model shown in Chart 2 indicates a plateau effect that takes place at each of the four growth stages. At the end of each stage, an impetus is needed to break the plateau so that a growth trajectory can be garnered again.

Maturity stageAt the maturity stage a consulting

company has to focus on building equity in the business. Building the net worth of the firm requires a steady flow of revenue and consistent profits. Establishing long-term contracts of perhaps 12 months or more with exist-ing clients, as well as having a diverse client base, is the key to success at this stage. Employing sound contract man-agement systems and efficient man-agement of large strategic accounts is imperative. Employing structured methodologies such as CMM, PMP, and ITIL have helped companies develop and expand contracts with existing clients. Maintaining a good billing, managing accounts receiv-ables, and timely debt collections are essential in keeping a low working capital requirement.

The current trend among con-sulting companies is to build their brand. Building a brand name instills confidence that business leaders have influence over the market. Accenture was the first consulting firm to market its brand image heavily and therefore, is highly regarded among business leaders. Big names such as KPMG, Deloitte Consulting, and Price Wa-terhouse have embraced this form of self-promotion as well. Brand names are built by advertising via TV, spon-sorships, magazines, and the internet.

Acquiring a competent work force and retaining it is crucial. Creating an atmosphere where the best people are hired and retaining them into the fu-ture through profit-sharing and stock option plans, will not only keep them focused on equity growth but will also ensure a growing business. Achieving an estimated growth rate of 15 per cent every year is good at this stage and

The revenue growth model indicates a plateau effect that takes place at each of the four growth stages. At the end of each stage, an impetus is needed to break the plateau so that a growth trajectory can be garnered again

Chart 2. Corporate Revenue Phases

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Gene

rate

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Mid stageEarly stage Maturity

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on ThE jobgenerates high equity premium. More than 80 per cent of business generated at this point should be through exist-ing clients. Long-term client relation-ships carry a high premium in the IT consulting industry, and should be carefully maintained and nurtured to build equity.

Exit strategyMost consulting firms believe that

there is no equity in a people business and it is all about fee income. Accord-ing to Plunkett Research, estimates of global consulting revenues including IT, HR, operations’ management, strategy, and business advisory ser-vices will be around USD 366 billion in 2011. Although 2009-2011 has posed significant growth challenges for con-sulting companies due to the economic slump, this in turn led to corporate downsizing and the future for con-sulting companies looks brighter for the next few years. Corporate profits have grown in 2011 and will lead to executives putting aside funds for consulting projects.

Even as the revenue prospects for consulting firms seem bright there has never been a better time to sell a con-sulting firm. 2006 saw a 40 per cent in-crease over 2005, in the acquisitions of small consulting firms and this market has been more active now than ever. Large consultancies acquire smaller firms because they see it as the best way to access client relationships and networks. Although other consulting firms waiting to acquire smaller firms represent a large percentage of buyers, they are not the only ones. The private equity houses are also on the lookout for small consultancies because they provide a good return on capital. A consulting business with a healthy profit and stable cash flow has a good chance of being acquired at significant valuation. If the company chooses to, it can restructure its debt so that a portion of the debt is shifted from a few primary stake holder or founders of the company to a large number of small stake holders. Alternatively, someone from within the company may want to raise funds from an out-side source and buy out the interest of the founder. Floating company stock

is a popular option as well. It involves selling a portion of the business in the form of shares to be publicly traded on the stock exchange.

An IPO may make more sense if the strategy is acquisition and expansion. In recent times account-ing or IT consultancies have tried to outsource IT to countries such as India. IT outsourcing requires a high level of investment outlay to support infrastructure. In 2000, KPMG filed for an initial public offering (IPO) in the United States to acquire equity. Accenture followed in 2001 and raised 1.7 billion through its IPO. Although IPOs can cause certain problems for consulting firms they are not without merit. It allows consulting companies to enter capital-intensive market segments and provides funding for acquisitions if necessary. Expansions funded by IPOs are not always the way to go, and pose a significant threat to consulting firms as exemplified by KPMG consulting. After going pub-lic in 2000, KPMG consulting went through some very troubled times. KPMG consulting renamed itself to Bearing Point in 2002. Unable to sup-port the expansion funded by heavy debt, Bearing Point filed for Chapter 11 bankruptcy in 2009. Additionally, before going public, companies must consider additional pressures of SEC financial reporting requirements, increased tax complexity, scrutiny by

analysts, shareholders, and the public.

ConclusionIT consultancies are a thriving busi-

ness. Not only do they have growth potential in the private sector but in the public sector as well. Between 2006 and 2011, the industry value added, which essentially measures the industry’s contribution to GDP was forecasted to rise at an annual average rate of 1.5 per cent and is currently generating USD 237 billion in indus-try revenue. IT consulting companies have enormous potential to grow if they choose to pay particular atten-tion to their business profit margins, manage their brand equity and their intellectual property. Whether they choose to mature and expand busi-ness or use any of the exit strategies depends on their long-term strategy and the corporate culture that the com-pany envisages. Human exposure to data is growing at an exponential rate. Effective use of this data requires the use of IT. Services required in this area will continue to grow as we deal with more information. Social networking may gradually change the nature of in-formation sharing and dissemination among people. We already read the newspaper less and watch less TV, as a significant amount of our time is spent on laptops and mobile computing devices. When we consider the need for mapping this cognitive network driven by behavioural paradigms, the complexity is incomprehensible. Clearly, these challenges will lead to the need for more services in the IT area and the growth challenges faced by these companies will become in-creasingly complex.

Human exposure to data is growing at an exponential rate Effective use of this data requires the use of IT. Services required in this area will continue to grow as we deal with more information

Tarun K. Sen Ph.D.Chief Operating Officer, Entigence Corporation, Washington DCParviz Ghandforoush Ph.D.Professor and Director MBA and Master of Information Technology Programs, Virginia Tech, Falls Church, VaThe authors would like to acknowledge the assistance provided by Vaishali Kamath, a graduate assistant in the Virginia Tech MBA program, for her assistance in developing the paper.

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