How Infosys Beat Expectations Despite Facing Fierce Competition

After a difficult 2013, the Indian consulting giant started the year right off by beating the Street consensus. How did Infosys manage to strengthen its business?

Jan 13, 2014 at 1:30PM

Consulting and technology company Infosys (NYSE:INFY) raised its full-year sales forecast on January 10, and surprised investors when it announced its operating margin rose 1.4% in the most recent quarter. The company, well-known for its premium pricing, also reported an amazing 21% jump in quarterly earnings.

Infosys' recent performance is outstanding, especially if we consider that corporations are continuing to decrease their tech spending. The company had a difficult 2013, as fierce competition among consulting firms -- such as Wipro (NYSE:WIT) and Cognizant Technology (NASDAQ:CTSH) -- made it hard for Infosys to continue charging elevated premium fees for its services. In this difficult environment, how did Infosys manage to thrive?

Infosys

Source: Infosys Investor Relations.

A difficult environment for offshore tech providers
The past five years have been quite challenging for Infosys. Commoditization for offshore technology accelerated after the recent financial crisis, as corporations were forced to cut their IT budgets. In response, competitors like Cognizant started offering similar services to Infosys at lower price points. Infosys failed to recognize the increasing price elasticity in the demand for offshore technology.

Instead of taking an aggressive pricing strategy, Infosys decided to continue charging a premium. On the bright side, this helped it to achieve high margins. However, Infosys' insistence on premium pricing also tempered the company's growth prospects. The result was a major decrease in revenue growth and stock performance. For example, in April 2013, after Infosys announced a pretty weak revenue forecast for the fiscal year, shares dropped almost 21% in a single day.

The turnaround: Infosys 3.0
Infosys finally realized that, in order to achieve revenue growth and protect its high margins, it needed to improve service differentiation. That's why the company decided to transform itself, from a technology solutions provider, to a business solutions provider.

For example, under Infosys' new strategy, the company seeks to reduce its exposure to the legacy application development and maintenance business, a segment where differentiation is hard to achieve. As a result, this segment represented almost 50% of total revenue in 2007, by 2012 it generated only 38% of revenue, according to Morningstar.

Now, Infosys is focusing on hot tech trends with high-growth potential, such as pervasive computing, which involves selling personalized software that is capable of analyzing real-time data from multiple devices. It is also focusing on emerging markets, mobile commerce, sustainability, health care, and digital media. 

Competitors
Among Infosys' most powerful competitors, are Cognizant and Wipro. Cognizant is a $30 billion Indian tech giant, which has managed to increase its revenue by nearly 30% annually, on average, during the last five years, according to Morningstar.

Cognizant's economic moat is based on delivering high-quality tech solutions combined with a personalized consultative approach. Unlike other competitors, Cognizant has built a U.S. based management team, which helped it to gain more customers in the U.S.

Wipro is also a big player in the global IT market, with high exposure to emerging trends, such as cloud services. The company dedicates nearly 10% of its total revenue to focus on research and development. This has allowed Wipro to build a strong technological advantage. However, with shares up more than 70% in the past six months, Wipro's price-to-earnings ratio is higher than Infosys and Cognizant.

Final Foolish takeaway
Recent financial results indicate that Infosys' turnaround plans are beginning to work. In the medium term, the company should be able to generate faster revenue growth, although margins may decrease due to increasing competition. Although Infosys is not a high-growth company anymore, it has more than 700 active and loyal customers. It also runs a recurring revenue model, which makes this company a must watch.

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Adrian Campos has no position in any stocks mentioned. The Motley Fool owns shares of Cognizant Technology Solutions. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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